You may know someone who has interest in a particular investment that borders on obsession: it’s all they can talk about. You may even know someone who has every penny they can scrape together in a single company’s stock, or a single real estate project, or even cryptocurrency. Not only have they put all their eggs in one basket; they’re practically living in the basket.
In the world of financial advising, we call this “a concentrated position.” That’s a professional way of saying that the investor is betting everything they have on the success of a single asset; if they win, they win big—but if that asset loses value, they can lose everything.
Now, most of us understand the value of diversification—putting your eggs in lots of different baskets. If one asset temporarily loses value, the diversification principle offers the hope that another, different asset will retain its value, or even gain. In this way, over time, investors gain a degree of protection from market volatility and its effects on the value of their portfolios. While volatility can never be completely eliminated, it can be moderated by properly diversifying the portfolio.
Small Business Owners Need to Diversify
Now, for a minute, consider a typical small business owner. They may have spent decades building their business. Over time, they have acquired the trust of customers, suppliers, bankers, and most important, their employees. These people are the backbone of the American economy; small business accounts for nearly half of the US gross domestic product (GDP).
Not only that, but millions of small business owners plan to retire over the next several years. In fact a survey by the Exit Planning Institute indicates that 70% of business owners age 50 or older plan to sell their businesses within the next 10 years, and the Small Business Administration estimates that some 10 million Boomer-owned businesses will be sold from 2019 to 2029. These people are reaching the age where they no longer desire to be actively managing their businesses. But here’s the problem: the average small business owner has 80% of their wealth tied up in the business. They want to back away from the day-to-day management of the business, but how will they do that and still fund the retirement lifestyle they desire?
The answer, of course, is diversification. These business owners have a highly concentrated position in their businesses, and they need to find ways to unwind that position and re-allocate assets into a more diversified portfolio that can help them fund retirement.
Diversifying Assets for the Small Business Owner
Fortunately, there are ways for small business owners, with some advance planning, to diversify their assets without compromising the business’s profitability or ongoing viability. Let’s take a look at a few of these.
- Employer-sponsored retirement plan. One of the greatest wealth-building tools for Americans is participation in a workplace retirement plan. And now, the SECURE 2.0 Act has made it easier and less costly than ever for small business owners to establish and maintain a 401(k) plan for themselves and their employees. With a 401(k) plan, small business owners can funnel a portion of the income generated by the business into a tax-favored plan that can allow for investment in a range of different financial assets, creating the opportunity for tax-free growth within the plan and funding for future retirement needs. A business owner participating in a company-sponsored 401(k) can deposit as much as $23,000 (in 2024), plus an additional $7,500 in catch-up contributions for those 50 and older. Not only that, but studies show that offering a company-sponsored plan for retirement saving provides an advantage for attracting and retaining the most qualified employees, which can make the business even stronger for the future.
- Succession planning. Especially for business owners in their 40s and 50s, for whom retirement may not yet be top of mind, succession planning might seem like something to think about “someday, when I’m ready to sell.” But succession planning isn’t just about selling your business. It’s about securing your legacy, protecting your financial future, and aligning your business with your personal values, goals, and objectives. Succession planning is simply good business strategy, it is value management that makes the timing of your exit less relevant. And remember: a well-executed succession plan doesn’t just benefit you; it also provides stability and growth opportunities for your employees, who have invested their time and talents in your business. Especially for those who intend to pass the business to a child or trusted employee, having a solid succession plan in place—including an appropriate funding mechanism—is an investment in not only your peace of mind, but also that of the employees, family members, and others who depend on the business for their financial welfare. In other words, succession planning isn’t just about exit strategies; it’s also about long-term growth. It forces you to evaluate your business, identify areas for improvement, and create a roadmap for future success.
- Know your value. And speaking of evaluating your business, don’t overlook the importance of having a solid valuation for your business as you begin your diversification efforts. This may seem obvious, but too many small business owners spend so much time in the business that they lose track of the business. Especially for those who anticipate using the proceeds from selling a company to fund a significant portion of their retirement, having an accurate valuation is a must. A professional valuation expert can help you take into consideration cash flow, customer base, assets, and other factors that directly impact the value you can justify to a potential buyer. For some businesses (construction, manufacturing, and others), seasonality and business cycle considerations may also be important. The more you know going in, the better prepared you’ll be to get the maximum value from the sale.
At Rothschold Wealth Partners, we know that every business is unique; there is no one-size-fits-all solution for small business owners who need to diversify. Since 1908, we have been providing wealth management solutions for individuals and small businesses. To learn more, please visit our website and read our article, “Why a 401(k) Plan Can Be a Win-Win for Your Practice.”
