Employees of publicly traded companies are often granted company stock as part of an overall compensation package. While that can be very helpful to growing overall wealth, holding outsize amounts of stock in the same company that you work for can increase concentration risk. If the business were to suffer, not only would the stock decrease in value, but the employee could also potentially find themselves out of a job. Employees who are granted stocks often mitigate this risk by selling some of the company stock and reinvesting it in other assets, to diversify growing wealth away from the source of income.
But what about when you own your business? The situation becomes more complex. Often times, owners find themselves putting all of their profits back into their business in excess of living expenses while they are growing it. The hope is to one day sell all or part of the business down the road to capture the value and gains at that point. With this strategy, retirement planning is often put on the back burner until the business has grown to a point where the business can be monetized.
We think there is a more thoughtful approach that may work for business owners.
The Key: Diversification
While it may seem like a good idea, relying solely on your business as your source of wealth can expose you to a lot more volatility than you think. Whether it’s saving for a rainy day, or longer-term goals like retirement, if all of your wealth is tied up in your business and your business dictates your moves. Creating and regularly adding to a separate investment portfolio may help diversify your assets. And if you invest away from areas you are already exposed to in your business, it can be a powerful tool to help you smooth volatility across both your business and life. For instance, if your business is vulnerable to cyclical sectors, you’ll want to create an investment portfolio that is defensive against periods that are unfavorable.
Retirement Savings Tax Advantages
There can be significant tax advantages to setting up the right kind of retirement plan for your business and ensuring that you set aside money to invest as close to the maximum as possible every year. While there are of course upfront fees and ongoing costs associated with formal retirement plans, they also allow you to save in a very tax-advantageous manner. Depending on your situation, a 401(k) plan, profit sharing and a cash balance plan are tools that allow you to put away tax deferred savings that can be utilized in retirement without depending on selling your business. They can also be a great way to attract and retain talented employees. In addition, having significant savings in taxable accounts helps you to accumulate reserves in the event of a cash shortfall and also strengthens your hand when applying for bank financing.
How About Timing?
When you’re putting everything back into your business with the idea that you’ll eventually fund your retirement by selling all or part of it, you’re essentially making two bets: That you’ll be able to sell when you are ready and not before, and that when you are ready the market for your business will be at a good point for an exit. Having to liquidate early because you are no longer able to run the business or having to sell when either the business is struggling can limit the amount you realize. You only get to sell it once, and your retirement life will be dependent on what you realize. If you’ve planned for a source of retirement income away from your business, you’ll have more flexibility when it comes time to sell.
If it is typical in your industry that sales are “seller-financed,” there is an additional level of risk that come with whether or not the new owner will be able to successfully operate your business, and make the promised payments to you on time, or at all.
The Bottom Line
As you’re building your business, it makes sense to think about your personal wealth as a completely different stream of future income. Thinking about diversification across your total asset profile can get you started on a journey to financial independence. If we can help you think through your game plan, feel free to reach out to us to begin the discussion. We look forward to hearing from you.
The commentary is informational in nature and not intended to imply a specific strategy or course of action. Investment advice and recommendations are only provided according to each individual’s personal circumstances. Chancellor Wealth Management is an investment advisor firm registered pursuant to the laws of the state of Georgia. The firm is also registered to conduct business in the states of South Carolina and Texas. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Copyright © 2021 Chancellor Wealth Management, All rights reserved.