Most owners I meet have almost everything they own sitting inside one business. The house may be paid for and there may be a retirement account somewhere, but the real net worth is the company.
I consider that a single point of failure, and it can be taken from you by things you did not do and could not have prevented.
So the question I want to answer here is a practical one. How do you build wealth that sits outside the company, and how do you do it while the company is still running well?
Our moves help you gain net worth and play defense at the same time. And none of them require you to sell anything.
Sometimes It’s Not Their Fault
I have always stressed getting net worth outside the company, because you never know what risks your business carries that could cause you to lose it all.
Companies get into trouble because of things outside their control. The government changes something. A whole market gets replaced because technology takes you out. There are any number of other ways companies fail and sometimes it’s because they get sued.
You must operate with the reality that we live in a litigious world. If your company gets sued and you have a lot of cash or a lot of wealth sitting inside that company, your whole net worth can be destroyed.
The thing to diversify, then, is the source of your wealth, not the portfolio.
Instead of reinvesting all of the money you earn back into your business, we start to apply a balance to growing your wealth. We take more income and distributions for the owners and get more aggressive in the way we use structure to set aside the most money in pension plans.
Normally, we play offense and defense with our clients, and part of the defense is pulling wealth out of the company, putting it in pension plans, and distributing extra cash so it can build assets somewhere else. This is one of the reasons exit planning is about more than just selling your business.
Here is what the defense looks like in practice.
1. Adequate Liability Coverage
The first defense is having adequate liability insurance. Too often we find mistakes in the amount of coverage that is carried. It is the cheapest of the five and the one most likely to be under utilized or missing, right now.
2. Pension Plans Funded for the Owners
The second is building the pension plans you can fund on behalf of the owners.
Should someone get a judgment against you, your qualified pension plan cannot be assigned or alienated. In plain terms, that means a creditor chasing a debt or judgment against you cannot get at the plan.
Get a judgment against the owner or against the company, and the plan is still standing. The Supreme Court settled this for bankruptcy in Patterson v. Shumate, holding that a plan with that anti-alienation language stays out of the bankruptcy estate.
The protection is strong, not absolute. The IRS can reach a plan for federal tax liens, and a divorce court can reach it through a qualified domestic relations order. Neither of those is a business creditor, which is the risk we are talking about here.
So the owner has assets sitting where a lawsuit aimed at the company cannot follow. If they lose the company for whatever reason, the pension plan assets are independent of that loss.
3. The Management Team
The third is the management team.
After working with a client for a while he became ill and was in the hospital for six months. We had helped establish a management team and diversified away from needing the owner in the day to day operations. The company survived, because there was a management team in place.
Sometimes, things happen that affect the company and it’s not the client’s fault. A management team protects the wealth of the company, and it also makes the owner less needed day to day, so the company can survive without him, which also makes the company worth more money. If you are still doing work only you can do, you are probably doing the wrong job in your own business.
4. Distributing Excess Cash to the Owner
The fourth is distributing cash that lets the owner invest in other things, including paying down personal debt.
Anything that makes their personal life safer belongs in the defense column. You can restart a company if you have assets and low overhead. However, it’s very hard to do if when the company goes under, your assets are all tied up in the company, or if there is cross liability somewhere.
5. Removing the Owner's Guarantee on the Bank Loan
The fifth is something we have done a number of times, going back years.
When companies take out loans to do business, most of the time the bank wants the owners to be a guarantor. So if a client has a history of being successful, we like to go back to the bank and renegotiate. If they want to keep the bank loan, we would like them to remove the guarantee by the owner.
That protects the owner if something happens in the business that is outside their control. His personal wealth does not go down the tubes with the company.
Where the Defense Becomes Offense
When you build a management team, you’re playing offense and defense at once, because it makes the company worth more money and the owner is not needed as much anymore. Kill two birds with one stone.
The same work that keeps the family safe, if the company goes down, is the work that makes the company worth more if it does not. Essentially it’s this: is your business is ready to be seen through a buyer's eyes? Remember, capital is a coward. A buyer that does due diligence on your company before purchase is looking for reasons not to buy it or to pay you less. But if there are no negative surprises, but instead positive ones, then a buyer is likely to pay you more money. They view your business as being a safe place for their money to grow.
What this Looked Like for One Family I Worked With
I had been working with a company for three or four years. Early in the engagement I had asked them to let me help them create wealth outside the business, so we distributed a lot more cash than they normally would have.
So we paid down debts, set aside funds, and created pension plans, among other things. By the end of it they had a significant amount of wealth sitting outside the company.
Then they went to market and we found a buyer. We were only a few weeks from close but, the state auditor showed up with questions about how the company was doing business. While there was nothing ultimately wrong, and the time and money involved was a nightmare. Unfortunately, the deal fell through before things got settled and it ended up killing a multi-million dollar sale.
The sale never closed. The company went to almost no value, and they had to start over from there.
The good news is the family was fine and they survived and thrived through that difficult period of restarting, because a significant amount of their wealth was already sitting outside of the company and there was available capital to restart the company…which they did.
