There comes a time in every successful entrepreneur’s life when he or she has to consider how best to transition to the preservation of the wealth they’ve built, not only for their own enjoyment, but also for the sake of the legacy they want to leave behind, says Director and Regional Head at Citadel, John Kennedy.
“The entrepreneurial journey is typically made up of two wealth management phases: the wealth creation phase, which can take years and years of hard work, and the wealth preservation phase,” says Kennedy, who has close to 30 years’ experience in financial planning. “The business is the financial lead domino in the entrepreneur’s life, the mechanism that pays all the bills. However, at some point in the life cycle of the business and the entrepreneur’s life it becomes important to shift the strategy away from pure wealth creation to a combination of wealth creation and preservation.”
DILUTING RISK AND MAXIMISING LEGACY
“Every entrepreneur will know when it’s the right time to do this gear shift – to monetise the business they have built.”
There are various ways that entrepreneurs can extract preservable value out of their businesses:
- By selling the equity in the business (or part thereof), cash out and reinvest the proceeds.
- Declare dividends to the shareholder(s) and, in this way, take some money off the (business) table that can be invested into a diversified portfolio.
- Plan for succession by bringing in professional managers or family members to continue running the business, which can provide an earn out mechanism and secure their retirement.
“What is critical, however, is that at some point in time, it’s no longer the business paying for the lifestyle – it should be the wealth that you have preserved and grown over the years,” explains Kennedy.
Entrepreneurs can spread the risks of their financial portfolios by virtue of:
- Accessing various geographies and regions,
- Investing in multiple asset classes,
- Beyond one currency,
- Holding instruments that are market priced and liquid,
- And, securing their long-term personal cashflow requirements via a well thought through financial plan.
“Making your finances more liquid is very important, because a person who is worth a significant amount of money all tied up in one business is potentially not as secure as a person who has the same amount reasonably diversified. If it’s liquid and market priced, the number means something different,” says Kennedy.
The pandemic exposed many risks to entrepreneurs. “The last two years showed us what can go wrong when things happen that are out of your control and that work against you for an extended period of time. It showed us that we all need to learn to de-risk what we’ve worked for all our lives.”
THE ENTREPRENEURIAL MINDSET
At some point in time, when the business is profitable and has matured, it becomes opportune to take some profits off the table to reinvest, precisely because the business carries concentrated asset risk.
Entrepreneurs are often ready to start de-risking when they reach a certain age, and typically that might be in their late 40s to mid-50s. This is when they start thinking about what they want to do and how they want to live when they are 65 or 70, who will succeed them and what they want to leave to the next generation.
“So you’ve grown whatever you’ve been investing your time and energy into in, and now you need to harvest. The real question is how much do you harvest and how much do you reinvest. If you quite literally own a farm, then you might start thinking about what you need to put away in order to be in a position to leave the farm to your children, or if farming is not their passion, how you exit the business in such a way that secures your requirements and those of your dependents.”
“It’s always best to do this in consultation with experts, who are able to remove the emotion and provide perspective and guidance through the process.”
CALCULATING HOW MUCH TO PRESERVE
Kennedy advises that there is a science to calculating the right amount and mix for a strong, diversified investment portfolio. It depends on the level of lifestyle that the entrepreneur wants to maintain and the amount that needs to be set aside for future generations, especially if there is a large estate in the mix.
“The last thing you want is for the patriarch or matriarch to stick around longer than they want to because they need the money that the business generates to pay their bills. At some point you need to weather-proof yourself.”
Calculating what and how much to unlock and invest for solid wealth preservation entails analysing the family and business structure and the role of all main parties, including the current and future role of the entrepreneur, looking at the business balance sheet, all business and personal assets, shares and dividends, income, liabilities, what business assets are liquid or not, and more. “When you understand the true value of the business – and most business owners initially overvalue their businesses – only then can you determine the quantum and structure of the investments you need, and how to diversify it optimally for both capital growth and preservation.”
“To move to the next phase of the entrepreneurial journey is a calculated and strategic process, absolutely vital and should be handled with the utmost care. It makes all the hard work worthwhile in the end.”
Written by: Citadel Director and Regional Head, John Kennedy