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Here are 6 actions business owners should take when planning for liquidity.
Despite the shaky U.S. economy, many entrepreneurs continue to start and grow their businesses here and amass great wealth in the process. But many of them aren’t adequately preparing for the day when they will need to unlock that wealth.
Many of today’s entrepreneurs are paper rich, with up to 90% of their net worth tied up in illiquid company equity. It’s not until they undertake a liquidity event-a full or partial sale of their businesses-that they will have the liquid assets normally associated with a person of affluence.
Yet most entrepreneurs don’t realize that their personal financial planning needs to begin well in advance of selling their business, which is the point in their lives when strategies can be implemented that have the greatest impact on tax management and legacy planning. It’s before, not after, a business is sold when much of the real financial work actually begins. Indeed, following a plan that allows for a seamless transition from one phase of life to the next is not nearly as easy as it may sound.
There are six actions that successful entrepreneurs must take before they undertake a liquidity event:
1. Build a “no sale” contingency plan – Considering the hit that market values took after the 2008 fiscal meltdown, entrepreneurs have to be prepared for a disappointing business valuation. It’s good to hope for the best, but be prepared to adjust your expectations downward. If the valuation of your business comes in lower than expected, it’s important to have a contingency plan to remain with the business a few years longer to maximize cash flow and increase value before selling. This plan should state precisely how many more years the business owner is prepared to stay.
2. Plan for a potential capital gains tax increase next year – The capital gains rate is set to increase from 15% to as much as 25% in 2013 without any action by Congress to extend the Bush tax cuts. Entrepreneurs who are not far along in the process of executing a liquidity event have very little chance of getting a transaction done before the end of the year. As a result, business sellers will need to plan for lower net proceeds in 2013 and beyond, or push their sale dates forward to build value.
3. Set up an advisory team that has a long-term view – It is vital to have advisors who can shepherd you through the rest of your life after a business sale is done. Build a team of advisors comprising a deal attorney, a deal investment banker, a CPA, an estate attorney and a wealth manager.
Certain team members will have a more lasting impact over time than others. While transactional advisors such as a deal attorney and a deal banker are essential, they are there to do one thing: get maximum value for your business. After that, their job is done.
Entrepreneurs also need an advisor who can put a comprehensive plan in place that will make the capital from a liquidity event last for the rest of their lives. Far too many entrepreneurs who have become exceedingly wealthy after a sale don’t have a permanent advisor in place to help them navigate the next phase of their lives.
4. Establish a cash flow plan that focuses on goals as liabilities – The key transition entrepreneurs have to make after a liquidity event is to go from having a steady stream of income to making one lump sum last for a generation-and hopefully beyond.
This plan should map out all goals and day-to-day concerns. Think of all goals as liabilities. For example, “survival liabilities” would include the cost of necessities such as food, clothes and health care. “Lifestyle liabilities” would include discretionary expenses such as travel, entertainment and dining, while “legacy liabilities” would encompass inheritances, endowments and philanthropy.
These liabilities may have to be adjusted periodically to reflect market conditions or other variables. It’s important to chart out each goal and corresponding liability before a liquidity event.
5. Name a “head coach” for your team of advisors – Make sure that there is a designated “first among equals” point person to act as the head coach of your advisory team. This person should be part of the process from the beginning, taking the lead from the outset and being plugged in with the deal banker and deal attorney in the valuation process.
In most cases, the wealth manager should be the head coach since he or she is typically concerned about the client’s broad, long-term interests. As previously discussed, deal bankers and deal attorneys fill temporary roles. The CPA and estate attorney are more permanent fixtures, but they fill special roles, providing services largely on a seasonal basis or services for intergenerational planning.
This leaves the wealth manager as the “all-weather” advisor, providing the client with continuity and consistency after a liquidity event is completed.
6. Determine equity gifts – Once a business is in play following a formal valuation process and/or signing of a letter of intent, the value of its equity will almost certainly go up. Given the current $5 million cap for gifting stock to family members, the sooner there is a plan for gifts, the better. Good planning possibly allows for tremendous intergenerational capital preservation down the line via tax savings.
For successful entrepreneurs, selling a business is not a financial cure-all. The key for high-net-worth advisors, therefore, is to make sure clients understand that financial complexity does not diminish following a liquidity event. Rather, complexity simply transitions from business-related financial decisions to an entirely new array of personal finance decisions.
Indeed, for the entrepreneur who has experienced a significant liquidity event, life sometimes may get more complex, fraught with the new challenges associated with making a onetime lump sum of cash last throughout an entire life (and beyond for future generations). With some effective “blocking and tackling” well in advance, entrepreneurs can take the first crucial step toward establishing a clear and seamlessly executed financial blueprint that will provide for them across generations.
Dean J. Catino, CFP®, CPWA®
President & Co-Founder
Pretty much everything in Dean’s life revolves around his family and friends. Dean married his high school sweetheart, Sheila, and they have three accomplished daughters that he is immensely proud of. For fun, Dean enjoys the serenity of fly fishing and the thrill of crushing the “cyber competition” on his Peloton bike. Of course, scoring better than Dave on the golf course always makes his day!
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