Even in the Days of COVID-19, Smart Planning Can Lead to Financial Freedom
Throughout American history, business success has been the foundation for family wealth. Think of industrial magnates like Henry Ford and John D. Rockefeller, as well as technology pioneers Bill Gates and Steve Jobs.
That entrepreneurial spirit is alive and well today for Coral Gables business owners, executives and professionals willing to tackle the risks of a new venture in hopes of significant financial rewards. But there are no guarantees of success in the business world, as fierce competition, poor management or unexpected events like the COVID-19 pandemic can crush those dreams.
To turn entrepreneurial hopes into long-term individual and family wealth requires an understanding of the key issues at every stage of the business cycle from startup to exit, according to Coral Gables financial planning and wealth management professionals.
Reflecting on the long-term process of turning a business into wealth, Jim Davidson, chairman and CEO of Coral Gables Trust Co., puts it this way: “Get a good education, and pick a field that you enjoy. Don’t look for easy solutions, take on the challenges, work diligently and you will be on the way to success.”
Success or Failure?
Launching, building and selling a successful business is one of the most powerful strategies for creating significant wealth. One example involves a Central Florida engineer who founded a manufacturing company decades ago. “He was able to do something he loved and turn it into financial freedom,” says Michael Walsh, wealth manager at Evensky & Katz/Foldes Financial Wealth Management, who advised the owner in a confidential client relationship.
“The entrepreneur came from humble beginnings and had to mortgage his home to make the payroll in the early days of the business,” says Walsh. “But he worked hard and brought in a professional manager to oversee the day-to-day operations as the company grew. Recently, he sold the business in an eight-figure transaction (more than $10 million). Now, he is looking at traveling the country, getting involved in philanthropy or going back to doing what he loves best, which is tinkering on machines in his garage again.”
But to succeed in business, an entrepreneur or executive needs to navigate a constantly changing set of risks. The U.S. Bureau of Labor Statistics estimates that 50 percent of small businesses fail in their first five years, and only 33 percent survive for 10 years or longer. To keep moving ahead on the path toward wealth creation, Coral Gables entrepreneurs need to protect themselves from bumps on the road.
“Risks are everywhere in business,” said Carlos Carbonell, managing partner of Firestone Capital Management. “Today, it is COVID-19, but there can be other types of macro events like a recession, as well as micro events like a divorce or a new child with special needs. That’s why financial planning is important whether times are good or bad.”
Carbonell emphasizes the importance of an insurance package that covers property damage, liability risks and business interruptions, such as an extended power outage after a hurricane. It’s also important to avoid overspending, because an expensive lifestyle can leave you financially overextended in the event of a problem with your business,” he says.
“Risk management is essential for any business, adds Davidson, who points to the importance of having adequate working capital and establishing a revolving line of credit to cover unexpected expenses. “You should also have a strong personal banking relationship, which can be very helpful in an emergency like the COVID-19 shutdown.”
Saving for the Future
“Business owners and professionals should begin the process of creating wealth as early in life as possible,” says Joseph Nader, managing director and senior wealth advisor of Calamos Wealth Management. “Planning ahead can make all the difference in the world.”
Indeed, along with building a business, young entrepreneurs and professionals should begin saving and investing. “Instead of buying a Ferrari with your first big check, start putting money into savings or a qualified tax-deferred retirement account like an IRA or a 401(k),” says Davidson. “Compound interest over the years can have a remarkable impact on building wealth.”
Davidson also recommends that entrepreneurs prepare a financial plan that includes their spending needs, as well as a tolerance for risk. While things can change over time, a personal financial plan can help align business activities with long-term goals, he says.
Carbonell says saving early gives entrepreneurs and professionals “a tremendous head start toward retirement.” Whether you make $1 million or $100,000 a year from a business or professional firm, you should save as much as is realistically possible, he says.
Walsh recommends maximizing contributions to 401(k) plans, which allow a participant’s nest egg to grow tax deferred or tax-free for decades. “These plans are also a great way for businesses to attract, retain and reward their employees,” he says.
Highly compensated individuals may also benefit from cash balance pension plans, says Nader. “These plans allow business owners and equity partners to put away several hundred thousand dollars a year in a credit-protected, tax-deferred retirement strategy,” he says.
In any case, entrepreneurs and professionals in their 30s and 40s should take a holistic approach to their personal finances, according to Jay Pelham, president of Kaufman Rossin Wealth. If you are finding it difficult to pay off credit card debt, for instance, you might want to reduce your 401(k) contributions temporarily and redirect those dollars toward lowering the balance. But if you have a low-interest mortgage, you don’t need to rush to pay it off. “Properly managed debt is not a bad thing,” he says. “Your mortgage payments may be tax deductible and with today’s low rates, carrying a loan could be part of your overall strategy.”
Getting a Strong Start
Preparing for an eventual business sale should begin right from the start of a new venture, says Pelham. “A business with two or more owners needs to have a written shareholders or buy/sell agreement in place. That can avoid some of the obstacles that can trip things up.”
A formal agreement among partners or shareholders can specify ownership responsibilities, limit individual liability and cover unexpected contingencies. It’s particularly important when friends or family members launch a new venture together, says Pelham. “If one of your partners died, would that person’s spouse get involved in business decision making?” he asks.
Even if the business started off with a handshake deal, rather than a written agreement, the partners can ratify those decisions later on, says Walsh. “It’s all about documenting a meeting of the minds between the partners or the stakeholders of the company.”
Whether launched by an individual or several partners, the legal structure for a new business entity should be carefully crafted to mitigate liability and other risks, says George L. Metcalfe, Jr., a trusts and estates and tax attorney at Day Pitney. For example, a multi-member limited liability corporation (LLC) can provide more protection against creditors than a single-member LLC, he says. Certain types of entities may also offer tax advantages to individuals, partners or shareholders.
Determining the Right Exit Strategy
Entrepreneurs can look at the pending sale of a business in very different ways. “For some owners, the decision to sell a business is easy, but for others it’s a very difficult process,” Nader says. “Some prefer a clean break, while others want to stay on for several years.”
Those perspectives can shape the owner’s exit strategy, such as whether to aim for a lump sum payment from a buyer or stay on for a transition period in return for an ongoing stream of payments.
Retirement planning should also involve a careful look at the owner’s current assets and goals, says Carbonell. “That can help determine an ideal sale price that provides enough funds for the owner to enjoy retirement,” he says. “There’s an emotional side as well, since some owners find it hard to walk away and wonder how they will fill the day. But after a year or two, many of our clients are enjoying life and tell us, ‘I should have retired sooner.’”
When planning for retirement, a financial advisor can run scenarios, such as working an extra one or two years before selling a business. “That can make a big difference,” says Pelham. “It’s also a way to extend your health coverage as long as you can. You might even sell the company but stay on as an employee to maintain that coverage.”
Another issue is finding the right buyer. Typically, there are two types of suitors: Current employees and competitors. If the entrepreneur wants to sell to employees, there are several options. “I have seen my clients enter into an earn-out arrangement where shares are transferred to the next generation of business owners and those employees buy out the founder’s share over time,” Walsh said. “Another method is to engage a third party, such as a bank or private equity firm, to finance the purchase.”
Carbonell recommends finding a business broker or investment bank that can provide an industry-specific valuation and assist in marketing the entity to prospective buyers. “Owners should also work with a tax advisor to see whether it makes sense to take a lump sum or an ongoing string of payments,” he says. “Sometimes you have to go with whatever arrangement the seller offers, but knowing the options can help you make a well-informed decision.”
Davidson notes that timing the sale correctly can do wonders for boosting the business’ value. “When the economy is struggling, buyers may be reluctant to make an investment,” he says. “You should also pick the right time in the life of your company. Buyers today want to see organic growth that is not tied to acquisitions.”
Whichever method is used to structure the sale, Walsh says it is critical for the owner to allow future shareholders to start running the day-to-day operations. “This route is often advised because all parties feel they have a stake in the future of the company,” he says. “Also, both employees and customers understand that there will be a transition of power in the future.”
Once a business sale is completed, the successful entrepreneur faces another set of challenges: Where to invest the proceeds to protect or grow that newfound wealth. That means setting new goals and updating financial and estate plans.
“While preservation of wealth is often the highest priority after a sale, that goal can be challenging in today’s low-rate environment,” says Carbonell. “A financial advisor can review the investment portfolio, projecting income and expenses in retirement, and help the retired entrepreneur use the proceeds of the sale to enjoy life in retirement.”