Are You Managing the Wealth in Your Business?
Too often, business owners focus on running their businesses and pay little attention to managing the wealth those businesses represent. To ensure that your financial goals are met, whether it is funding a comfortable retirement, leaving a legacy for your children or employees, satisfying your philanthropic objectives, or all of the above, it is important to treat your business as an investment.
Let's create a visual example to explain: Ralph, a 55-year-old business owner has $3 million in liquid assets held in a diversified portfolio that earns a 10 percent return. He’s also the majority owner of a privately held business, but doesn’t have it appraised regularly. If he did, he would know that his interest in the business is worth $12 million and that his return on investment (ROI) in the business is 6 percent. That means his overall ROI for the portfolio and business combined is only 6.8 percent.
Ralph happily pays his money manager a 1-percent fee equal to $30,000 per year, to help ensure that his liquid assets earn above-market returns. Yet he doesn’t invest in activities that could potentially boost returns on the wealth he has tied up in the business and better diversify his holdings, even though such activities ought to be worth at least $120,000 per year (1 percent of $12 million). Examples of activities Ralph might consider include:
- Auditing or other attest services that can enhance the business' financial performance.
- Annual legal reviews.
- Annual appraisals to gauge value and growth.
- Executing (and regularly updating) a buy-sell agreement to ensure that the company can buy out departing shareholders at a reasonable price.
- Purchasing life insurance to protect the business against the loss of key executives.
- Engaging consultants to improve the business' performance.
- Estate and financial planning.
Ralph should also consider various liquidity strategies he can use to tap the wealth he has tied up in the business, better diversify his assets, and potentially enhance his overall returns. Examples include having the business pay dividends or redeem shares, selling shares to an employee stock ownership plan (ESOP), going public or merging with a public company, and partial or total sales to family members, management, or third parties.
Ultimately, ownership and management of the business will change hands. The question is whether you passively allow these decisions to be made for you or actively plan your exit in a manner that maximizes the benefits for you and your family. Treating your business as an investment ensures that you manage all of your wealth, not just the wealth that’s invested in liquid assets, maximizing your growth potential.