Many successful entrepreneurs fund their small businesses with personal capital. It’s also common to reinvest earnings to support growth. If you’ve taken this approach in your own privately-held business, it’s likely because you anticipate a future payoff. For instance, funding your eventual retirement by selling your share. And while there’s nothing inherently wrong with this strategy, there is a flip side to every coin. Specifically, you may end up with a concentrated position in your own company stock, which can be difficult to unwind. In any event, it’s worth considering the following liquidity and diversification strategies to balance your risks.
Strategy #1: Start an Employee Stock Ownership Plan (ESOP)
ESOPs are defined contribution plans that primarily invest in company stock. They’re an increasingly popular exit strategy among privately held businesses given their flexibility and potential tax advantages.
An ESOP can be a great diversification strategy. For one thing, it allows you to gradually reduce your ownership stake over time to free up liquid capital. And if you’re not planning to retire in the near-term, you can transfer ownership to participating employees without giving up operational control.
There are also a number of business advantages to implementing an Employee Stock Ownership Plan. For example, research shows ESOP companies are more productive, faster growing, more profitable and have lower turnover—all factors that can increase the value of your business. Not to mention, it’s a great tool for recruiting and retaining top talent.
Despite the many advantages, ESOPs don’t make sense in every situation. Primarily, an ESOP means you must plan for the ongoing sustainability of your business. If this isn’t your priority, you may want to look into other diversification strategies. In addition, the administration of an ESOP can become costly.
Strategy #2: Build a Cash Reserve
Another option is to gradually build up a cash reserve. There are two main ways you can do this.
First, you can develop an exit plan that lets you transfer ownership to your successor over time, rather than all at once. This strategy gives you the opportunity to spread out your potential tax liability over several years. It also allows you to gradually develop an investment plan for the proceeds. This can be less overwhelming than trying to invest a substantial lump sum payment.
Alternatively, you can begin to set aside capital distributions or income that you would normally invest back into your business. As your cash reserve grows, you can invest it in a diversified portfolio of liquid assets. That way you’ll have immediate access to your funds post-sale–or in the interim, if necessary.
Strategy #3: Fund a Retirement Plan
According to a recent study, 34% of small business owners do not have retirement savings plans for themselves. Furthermore, the fewer employees a business has, the less likely it is to offer retirement benefits. If your business falls into this category, funding a retirement plan may be a great opportunity to reinvest in your business while diversifying your personal capital.
Similar to an ESOP, offering retirement benefits can make you a more attractive employer to talented candidates. You can also structure the plan in a way that incentivizes your employees to work for the good of your business, which may ultimately increase its value.
At the same time, you can use your retirement plan to diversify your personal assets. Meaning, you can invest in funds that have a low correlation to your business and industry to reduce your overall risk. Investing in a retirement plan creates a pool of capital that you can draw from when you eventually exit your business.
Long-Term Advantages of Liquidity and Diversification Strategies
When the economy is strong and markets are performing well, liquidity and diversification strategies tend to be lower priorities for entrepreneurs. Still, part of managing a successful business—or personal financial plan, for that matter—is preparing for the unexpected. It’s better to start thinking about these strategies sooner rather than later, especially if you’re planning to exit your business in the next five to 10 years.
Oak Capital Advisors specializes in exit and retirement planning for Charleston-based entrepreneurs. If you’d like to speak with a fiduciary financial advisor about diversifying your assets and developing a personal financial plan, you can get started by requesting a free retirement assessment.
