Episode 43: The hidden risk behind business success

Oscarlyn Elder:

Successful entrepreneurs often assume that building a great business will naturally lead to secure and lasting personal wealth. But in reality, the two don't always move together, and sometimes they move in very different directions.

I'm Oscarlyn Elder, head of investment management at Truist Wealth, and this is I've Been Meaning To Do That, a podcast from Truist Wealth, a purpose-driven financial services organization. We appreciate you listening.

Business owners have a unique set of opportunities but also unique risks. Their wealth is often tied very closely to the business that they've worked so hard to build. So it's easy for them to stay focused on the company while personal financial planning gets pushed to the back burner. Today, we're talking about why business success doesn't automatically translate into personal financial well-being and what business owners can do about it.

My guests are two colleagues here at Truist Wealth. Victor Santiago is a senior wealth strategist, and Julie Farah is a senior trust advisor. They're also contributors to a new Truist Purple Paper on this topic that's available for you to read. Welcome, Victor and Julie.

Victor Santiago:

Thanks, Oscarlyn. Great to be here today.

Julie Farah:

Yes. Thank you, Oscarlyn, for inviting us to speak with you today.

Oscarlyn Elder:

Victor, it might feel natural to a business owner to equate the success of their business with the health of their personal finances. What's the risk of that way of thinking to the business owner?

Victor Santiago:

Great question, Oscarlyn. Oftentimes, even the most successful business owner won't apply the same discipline to review the success of their personal financial plan. A very savvy, successful business owner can certainly be forgiven for assuming that their success in the business automatically translates to personal success. Oftentimes, they're not considering a host of factors. Even the most successful business owner should always be mindful of the risks that may await. How many people one to two years ahead of COVID actually planned or predicted it? There are issues out there that they cannot control that are systemic sometimes, economic, global, perhaps, or maybe even local to their own markets that may affect their business at any time. Much like stocks and stock markets, business value grows slowly and steadily, but it falls quickly, depending on a host of factors, so oftentimes, the owner takes it for granted. And unfortunately, we've seen it all too many times too late that they fail to plan for a major contingency.

Oscarlyn Elder:

Victor, that's very impactful, so I want to make sure that folks hear it. So what you're saying is that if the focus is just the business and the business owner hasn't given their own personal financial situation the appropriate amount of attention as the business goes through cycles potentially or has an external shock to it, then it may make navigating this business cycle or shock more challenging because they may not have built up the personal plan to withstand such a shock.

Victor Santiago:

Precisely. For a business owner, you really can't make the most informed decisions about what you want from the business long-term until you've asked the questions about your personal goals and what you really need to extract from that business. Regardless of how invincible the most successful owner feels, even that person knows someday they'll no longer be here. So transition, as we say, is inevitable. What's important is understanding how these two major pieces interact. Likewise, you can't really solve the personal plan until you have reliable estimates of business valuation, business income, and any other data that would otherwise impact your personal or financial goals.

Oscarlyn Elder:

How do business owners react when you bring up the importance and the connectivity with the personal planning?

Victor Santiago:

It varies. It takes time both to warm a savvy business owner to the notion of focusing on this and adding this to their regular list of things to audit and monitor. There are, of course, many business owners who love the idea but are always so busy or so distracted by new opportunities that they always fail to find the time to start. We've tried to ameliorate that dynamic as much as possible, trying to shorten conversations, trying to make the process much more accessible to a business owner on the front end so that it can be broken up into manageable pieces, but still probably one of our biggest challenges is getting the business owner to adopt this kind of planning mindset, if you will.

Oscarlyn Elder:

Yeah. So often business owners are going in multiple directions they can have, might be perceived as short attention spans, but the reality is they're often just hyperfocused on what they care most about, which often is that business. So that's one of the challenges. Are there other challenges that you see when you're working with business owners that we should talk about?

Victor Santiago:

One that I think I see more often than others, it's that business owners often tend to protect cash at the business level, either for future anticipated needs or just because it gives them an added measure of asset protection, but unfortunately it offers no protection for liabilities of the business. So oftentimes, business owners are not only overly at risk for excess cash held on the corporate balance sheet, but more often than not, unfortunately, we're finding these large cash deposits literally sitting in cash holdings. So they're not growing at a rate that outpaces inflation. They're not being maximized either for growth or for reinvestment in the company or in certain incentive plans that might be helpful to value.

Oscarlyn Elder:

Julie, let me turn to you next. You're a trust advisor, so you think a lot about how wealth is structured and eventually passed on to others. What stands out to you that business owners should be aware of as it relates to this issue of structure?

Julie Farah:

Well, Oscarlyn, that's a great question because, oftentimes, business owners will create a company without the thought in mind of how to get that company down to the next generation. So as the business grows, we need to reevaluate what that business structure is. In some cases, we might want to create voting or nonvoting rights so that we can be able to sell or gift nonvoting rights to the next generation. And when the business owner is ready to give up control, then they can relinquish the voting rights.

Oscarlyn Elder:

So, Julie, when a business owner hasn't been deliberate around structure as time has gone on, what can that mean for the family or the chosen family who may be left behind after a business owner passes away?

Julie Farah:

Well, poor structure can lead to wealth being trapped inside the business, and it will also limit the estate planning techniques that we might be able to utilize. Business owners, they often have more than one child, and there might be one or two children that are interested in being involved in the business, and there might be other children who are not. So oftentimes, you need to assess which of my children really want to take on this legacy, and then for those children who do not, how do I provide to them an equal amount of liquidity?

Oscarlyn Elder:

Yeah, so I hear in your response, again, this concept of liquidity and how important it is for business owners, and then also just so important in the estate planning process and the ultimate continuation of the life of the business.

Victor, let me go to you for a second here. No business owner wants their personal wealth to evaporate, so why is prioritizing the time for planning such a struggle for business owners?

Victor Santiago:

This is another one of those areas that we commonly have to contend with, and you'll find analogies to just simple personal planning when we talk about how clients have a fear of mortality, for example, and so they tend to put off planning around these kinds of things. Take that dynamic and multiply it by 100 for a business owner because, for the business owner, it adds the added element of identity. To ask any business owner to contemplate transition is often to ask them to contemplate a life without their current identity. So it's a very human response, something that our advisors are well-trained on to approach the client when they're ready, but also ensure that our clients are educated about the issues they will need to start attending to before too long.

And as it turns out, oftentimes, something happens that causes that owner to initiate the planning. Perhaps there was a death in the extended family. Perhaps there was a business event. Perhaps one day a customer was so cranky on the phone that the business owner said, "What if I just walked away today?" There are any number of business transition scenarios that can be modeled and planned for long term in order to give any business owner a better sense of the future, which helps them make much better decisions along the way.

Oscarlyn Elder:

Yeah. You bring up an interesting point, Victor, which is the issue of identity and how often intertwined identity is associated with what the business owner has created. I think what we're saying is that having that awareness of one's identity, how it's defined, acknowledging that but not using that as a crutch to basically delay planning is actually really important.

Victor Santiago:

And I do like how you described it just then, Oscarlyn, because certainly we don't want to discourage business owners from living their best lives. If you'll remember your history, the concept of retirement wasn't one of leisure originally. It was one of how long can you physically do your job? Perhaps in the last generation, we've seen more and more business owners say, "I will work well into my 70s so long as I'm healthy enough to do it." But life expectancies are generally trending higher. And to your point, if they don't plan consistently, especially at those upper ages, then the probability of something not working in their favor just increases.

Oscarlyn Elder:

My father, in his late 70s, is a business owner. He started his business in his 20s, and it is integral to his identity. And he still works and scoffs at the idea of retirement. And so I feel like I live this on a regular basis. But it is important, especially for business owners, to think about the what-ifs, to think about the structure.

And, Julie, I'm hoping that you can give us some additional risks that you would have folks think about that might help them understand the importance of beginning to engage in financial planning as a business owner.

Julie Farah:

Absolutely, especially since you mentioned earlier about how I'm focused on the wealth transfer aspects of a business. Oftentimes, the business grows and has a lot of value, but going back to that liquidity concept, there might not be enough liquidity to pay the estate taxes upon death. So there's different planning techniques that we can utilize, and hope that everybody listening will take a look at our Purple Paper, where we discuss some of those.

One way that we can create some liquidity is through insurance. You can create some liquidity at the business level, or you can create liquidity at the family level using insurance to take care of those anticipated expenses.

Oscarlyn Elder:

That's very helpful, Julie.

Victor, I'm going to go back to you. Let's talk for a moment about overconcentration, and we know that that's a risk often for business owners. I would like for you to define overconcentration and tell us how does it come about and how you would recommend folks thinking intentionally about managing it to avoid it becoming a much larger risk.

Victor Santiago:

From my perspective, an overconcentration means any particular asset that represents a large enough percentage of a person's overall either net worth or income streams, which, if suddenly threatened, would cause a material disruption to that person's long-term financial plan. It's very common to speak of stock concentration. We often don't want a lot of our clients to hold more than 10%, sometimes not even 5% of any one individual holding or even sector because that is consistent with what we've learned over years about the benefits of diversification.

With a business owner, it's much more acute because it's the business itself that is the concentration. And so, when planning for a business owner, we need to make sure that the business owner isn't just focused on the "day-to-day" and the success of the business, but that that focus is with an eye towards either business value or long-term continuity, because as far as their personal plan goes, the business is the largest concentration and therefore the largest variable. Obviously, the higher the valuation, the better you are. Focus on valuation and income generation and you want to leave it to your family, and obviously the stronger financial position over time helps ensure that the transition is affordable to both sides.

Oscarlyn Elder:

Julie, what would you add to what Victor has shared, and specifically how does overconcentration, what does it look like when you're reviewing a client's personal finances?

Julie Farah:

When a business owner has an overconcentration in their business, then oftentimes, you see the personal cash flows are restricted. They're dependent on the company's performance, and sometimes that can be a limitation.

Also, too, what we see is oftentimes business owners will operate their business and then as they need cash, they're reaching their hand into the business to get that cash. And honestly, we need to treat that business with a certain amount of formalities. Treat it like it's an operating company to be able to maintain the estate planning techniques that we have implemented.

The other thing I see with overconcentrations is that that means that there's a significant exposure to one industry or market cycle that's tagged with that business. So just like Victor was saying with investment concentrations, we could have a very big concentration in a certain industry, so then when we're looking at their personal investments, we need to maybe have investments that are outside that industry.

Oscarlyn Elder:

I think you both have given us a good idea of the stakes for the personal financial plans of business owners. We'll talk about solutions to these challenges when we come right back.

Victor, we've been talking about some of the risks business owners face as they plan or fail to plan for their personal finances. Once an owner recognizes these risks and gets on board with the planning process, where do you like to start?

Victor Santiago:

I like to start by reviewing as many of the standard financial information documents that the client could share with us, things like a personal financial statement, things like personal tax returns, but also I find corporate tax returns and balance sheets handy to review in order to get a sense of what that business does look like on paper, and then really find the time for the owner to focus on thinking about what they want for themselves in the future. You wouldn't believe how hard a question it is for a successful business owner to answer how much do we want to spend in retirement? How much do we want to spend every year once we're no longer tied to this business? Oftentimes, they don't have the particulars. Oftentimes, we talk in generalities.

It's amazing how much of the human side we take for granted in planning around the legal, technical, and tax side and valuation side. So oftentimes, for a business owner, it's a big aha moment. From there, it's a question of what sort of illustrations to run. What if I sell the business in three years? What if I slowly transfer the business to my two children in exchange for a promissory note? There's any number of possibilities.

And then what we do is basically stress-test the client's personal goals. In a very simple illustration, a business owner should at least have a well-reasoned estimate of what minimum amount they would need to extract from the business today in order to fulfill the goals on the personal side. It's a very simple concept, but it does take a lot of this data to give your client a recommendation you're confident in. It's not a simple process, in my opinion.

Oscarlyn Elder:

How long does that process typically take?

Victor Santiago:

It depends on the client and their timetable, of course, and their urgency, but if the client says, "I need this ASAP," then it should really only take a matter of a couple months if you're focused on it.

Here's the issue. Giving your financial planner all the information they ask for is about as fun as assembling your 1099s for your CPA in April. It gets put off. It's not because they don't want to send it. It's because they don't have somebody they can delegate it to and trust because it's personal financial information. Oftentimes, that's the biggest delay factor, and from there, it's really all about meeting the client where they are. This is not a process that we try to fulfill in one or two meetings. This is not a process where we give you a pretty little leather-bound booklet and wish you well. We have a team surrounding the client at the center of every relationship, and it's our duty to give the best advice possible, but also help the client to implement these recommendations with their outside professionals. That's an area where someone like Julie is paramount, very critical and crucial in the whole process.

Oscarlyn Elder:

Well, Julie, Victor has handed it off to you. So as those plans take shape, what are some of the key areas that you focus on to make sure that everything actually works for the client and their family over time?

Julie Farah:

Right. So Victor was talking about how he looks at the financial aspects and I look at the estate planning documents and the business documents to see how they're structured, how they're owned, how they're going to pass to the next generation. And just like Victor said, we do what-if scenarios, like what if both husband and wife were to pass today, what would that look like? How do those assets flow?

And I'd like to also mention, Victor was talking about it's not as easy as just getting your 1099s together for a tax season, but here when we're looking at financial plans, there's no deadline, so there's no real incentive to get it done. So oftentimes, our business owners, again, hyperfocused on the business, they're putting this aside, they're not putting the focus on it, but it's very important for them to work on their financial plans, both on the business and the personal side, way before they plan to exit the business. Because when they get to the point where they're going to exit the business, there's so many other things that they're trying to negotiate and work on that has to do with the business.

So I think it's very important for them to outline their personal goals before it gets to the point where they're ready to transfer the business. Oftentimes, when business owners are selling a business, for instance, they get an opportunity to continue to work for that business. They also get an opportunity to maybe retain some equity in that business. So through a personal financial plan, we can include that future salary or that future growth to determine if those things are going to be available to them to meet their personal goals.

Oscarlyn Elder:

I want folks to hear how important it is that business owners try to do that ahead of making a decision to monetize a business, whether to sell it, to not sell it, but it's very important that they allocate time early to really contemplate what it is they want to do.

Julie, can you give us an example of how planning ahead really helped a client find their way through all of these complexities?

Julie Farah:

Well, I can tell you, Oscarlyn, we're meeting with some clients right now, where we're having very candid conversations with two families who are involved in one business. And we're having these what-if conversations to determine whether or not the children of each of these partners really want to work together if both of those partners are deceased. And we're learning a lot of important information about whether or not that business will be successful should those partners pass away. And we're learning that they're probably not going to be able to work together, and so we need to find ways to reevaluate the business structure to be able to pass on the value of that business in a way that the partners feel are equitable.

Oscarlyn Elder:

These sound like very intense and potentially difficult conversations. How have these families been able to approach the conversation, approach the journey with the help of trusted advisors?

Julie Farah:

Yeah. In this particular case, we would meet with the children without the parents there and have very candid conversations and ask them, "Do you want to be part of the business, or would you rather be cashed out?" And sometimes this was new information to the parents because they just assumed that all of the children wanted to be part of the business. And then when you started asking them questions about how they got along with the children of the other partner and whether or not they see themselves working with them, and also asking them where problems might be that we need to work through because they see things that the parent partners are not seeing. Their relationship with the business is different than their parents' relationship with the business.

Oscarlyn Elder:

So what I'm hearing you say is that working with a team of advisors, we have helped facilitate really meaningful conversations in a safe place so that information can be shared, perspectives can be shared that will be instrumental in helping to craft the structure for the future and the estate plans for the future.

Julie Farah:

And in this particular case, we were able to identify some opportunities. It wasn't just one business. They also had subset businesses that were connected, and then we identified that there's this other business out here that maybe they could sell that part to come up with the liquidity to be able to buy out the other partners. Sometimes children, they weren't the ones creating it, so they don't have the mental limitations like the creator has. They're seeing it from fresh eyes and fresh perspectives, and they might see the vision of the future of the business in a whole different light.

Oscarlyn Elder:

Julie, that's great perspective, and I know that that has the potential to be impactful for other business owners who are hearing this, the importance of the children's perspective because they have a different relationship with the business, a different vantage point. It's very powerful and doesn't get talked about enough.

Victor, one of the themes that comes up a lot in the new Purple Paper and in these conversations with clients about their personal wealth is liquidity, and that's having the cash you need when you need it. The idea of cashing out of their business is not the goal for many business owners. Are there ways they might be able to create that flexibility and liquidity without cashing out completely?

Victor Santiago:

Yes, there are. One way to create some liquidity while still retaining ownership and control of the business is what's referred to as a dividend recapitalization, which is, in simple terms, when a company borrows to fund a distribution to an owner. It's basically taking a loan to move that money out onto your personal balance sheet and start deploying it for your personal financial goals going forward, something that we feel many owners not only haven't heard of yet, but don't take advantage when they do because they don't see the benefit to it.

From my point of view as a planner, it's purely a diversification play. Rather than wait until the day where you sell the business, which could be 20 years from now, let's take some of that value now, put it on your balance sheet, and use it as the nest egg upon which you build the rest of your future. If you're looking at it from that point of view and, again, you're marrying the business planning to the personal planning, then I think you have a higher rate of success than you otherwise would have.

Oscarlyn Elder:

Victor, thank you for sharing that one particular strategy. And what we recognize is that there are unique paths, and when it comes to a technique, like a dividend, recap, it's important that business owners are having conversations with their advisors and with their bankers to see if it might be appropriate for their situation.

And, Julie, let me go back to you. With the multiple approaches and strategies that are available for the issues that we've talked about, how would you suggest business owners think about finding their particular path?

Julie Farah:

Well, there's really no one-size-fits-all when it comes to planning. We start with their personal goals and back up and see how we get connected to those goals. It's going to be dynamic, and it's going to change over time because things in our lives just change over time. We have children; we have grandchildren. Our children and grandchildren might move away or come back, go off to college, come back. And so we try to help them reevaluate their goals and help match the techniques to meet their goals, and it's very important to start early on.

And our clients need to also know that we will walk through trying to assess what the valuation is without getting an official appraisal because there's certain planning techniques that are out there that you want to go ahead and gift or sell to the next generation an interest in the business when it's at a low valuation, and then later on, you sell it at a higher valuation. So we want to avoid getting an official letter of intent to buy the business until we've already done the planning. So it's really important to initiate that planning early on and not wait until it's time to sell the business.

Oscarlyn Elder:

That's a great point, Julie. So you're talking about part of the theme here is start it early; engage in the journey. There's information that if you gather early, there's certain techniques that, if appropriate, could be well-served with that earlier planning that can result in potentially a significant advantage over time. And I'll just point out that we don't give direct tax or legal advice here at Truist. So anytime we're engaging really in this more detailed advice-giving around business and business monetizations, it's always important that we're working with our clients' tax and legal advisors to deliver that advice. So thank you for calling that out, Julie.

Victor, if I'm a business owner listening and realizing now that maybe I haven't been giving my personal finances enough attention, what's my first step?

Victor Santiago:

Well, a lot of what we're talking about today is explained in more detail in a recent publication, in one of our Purple Papers, which I think is a great place to start. After that, simply make contact with one of our wealth advisors who can get to know your situation and introduce you to the right teammate here at Truist who can walk you through the planning that we need, whether it's myself, Julie, or a host of other potential teammates that can essentially meet the client where they are at that point in their life. The Purple Paper does a really nice job of covering all of these issues, and a couple that we don't have time to talk about. And when you're interested in learning more, reach out to your wealth advisor and they'll make the introductions from there.

Oscarlyn Elder:

The Purple Paper is a great place to start, but with every situation being unique, personalized investing is important too. Thank you both for all the insights that you shared with us today. It's been a wonderful conversation, and I think this is going to be so helpful to business owners and their families who may be listening in.

But you can't go quite yet because there's a question that I always ask our guests, and I'd love for you both to answer. We always ask what's the one thing that you've been meaning to do that you haven't done yet and that you're willing to commit to doing now with our audience listening in? So, Julie, why don't you go first?

Julie Farah:

Well, I've got a little variation to this, and it's very analogous to what we've been talking about today, but I've already implemented about a week ago when my son came home from college the commitment to invest more personal time and effort into our personal family relationships. I've been focused so much on my career over the last few years, and now that he's home and we now know that his college is paid for, I've made the investment in a boat so that we can create some new family memories.

Oscarlyn Elder:

That's fantastic, Julie.

And, Victor, how about you?

Victor Santiago:

Recently, I've been invited to present to some college graduates on general financial literacy topics. And surprisingly, I found that to be very rewarding, just to be able to get in front of that age group and impress upon them the importance of starting as soon as possible and instilling in them a lot of very important financial disciplines. In researching other opportunities to reach that audience, I came across a designation, a company that offers a certification for people who want to teach financial literacy topics, and I'd like to learn more about pursuing that. Not because I think I need it, but what I think I need is a better understanding of how to reach that generation. I'm afraid I might sound like a stuffy old professional to them. So I think investing time to do that might help it be more impactful.

Oscarlyn Elder:

You both have two amazing to-do items. I look forward to checking in and seeing how those journeys are going. And so, Victor and Julie, I want to thank you both again for joining me today for this important conversation.

Victor Santiago:

Thank you, Oscarlyn. Thank you for having us.

Julie Farah:

Yes, we appreciate the opportunity to visit with you today.

Oscarlyn Elder:

And, listeners, I want to thank you as well. If you liked this episode, please be sure to subscribe, rate, and review the podcast and tell friends and family about it. I also invite you to listen to the podcast from Truist Securities, Navigating Beyond the Expected, at Truist.com/BeyondPodcast.

If you have a question for me or a suggestion for this podcast, email me at DoThat@truist.com. I'll be back soon for another episode of I've Been Meaning To Do That, the podcast that gets you moving toward fulfilling your purpose and achieving your financial goals. Talk to you soon.

Speaker 4:

Oscarlyn Elder is an investment advisor representative, Truist Advisory Services, Inc. Any comments or references to taxes herein are informational only. Truist and its representatives do not provide tax or legal advice. You should consult your individual tax or legal professional before taking any action that may have tax or legal consequences.