The Business is Not Enough: A Case Study in Diversifying Wealth as a Business Owner

When you’ve spent years building a successful family business, it can be difficult (nearly impossible, even) to take a step back and review your financial landscape with an impartial lens. But if you’re like most, your personal wealth blends with your company’s financial well-being, making it difficult to discern where one ends and the other begins.

In the case study narrated below, we’d like to demonstrate a common financial scenario for husband-and-wife business owners. Then, we’ll identify opportunities for diversifying wealth beyond the family business.

The Scenario: Johnson Contractor Services

Rita and Adam Johnson own a general contracting business together. Adam is often on-site overseeing projects, while Rita handles the majority of the business’s finances and back-end operations.

When the Johnsons went into business together, they initially invested $100,000 of their own cash savings. But in the decades since starting Johnson Contractor Services, they’ve worked hard to build a successful and highly profitable business together.

Today, they live comfortably by taking a salary from the business to cover their own financial obligations, but most earnings go back into growing the business for the future—buying new equipment, expanding their marketing reach, hiring, etc.

The Johnsons are still about 10 years from retirement and haven’t put much thought into how they’ll exit the business. They assume they will eventually sell the business and use the proceeds to fund their future retirement needs.

But as we’ll dig into more below, this assumption can be a costly one, and it may impact their ability to enjoy a long and financially secure retirement.

Why Is Diversifying Your Portfolio Important as a Business Owner?

Nobody likes to think about the worst-case scenario, but in order to build an all-weather portfolio, we must look at what risks the Johnsons could be unknowingly exposed to and ways to mitigate these risks.

The assumption that a future business sale will solely fund their retirement overlooks important considerations and potential risks.Concentrating a significant portion of wealth in a single asset, regardless of its past performance, exposes entrepreneurs to unnecessary vulnerabilities. A more robust strategy involves proactively exploring options for wealth diversification beyond the business itself.

Risk Management

As a reminder, the Johnsons built their wealth working in the construction business. While they’ve enjoyed many years of prosperity, let’s consider what would happen if a recession were to happen.

Construction is not a recession-proof industry; in fact, it’s one that gets hit the hardest during any type of economic downturn. During the 2007-2009 financial crisis, the construction industry in the U.S. alone experienced around 2.5 million layoffs, and nearly 150,000 construction companies closed their doors.

The future is uncertain, and there’s no telling what will happen at a macroeconomic level—especially when you look ahead closer to retirement. If an economic downturn occurs right as the Johnsons are ready to sell the business and retire, it could jeopardize both their immediate cash flow and future retirement income.

Diversifying wealth beyond the family business can help protect your family from unexpected events (like a global recession) while also opening the door to other investment opportunities. 

Tax Efficiency

Nobody wants to pay more in taxes than they have to—we know this is something every business owner is acutely aware of. If you aren’t diversifying the tax treatment of your earnings, you could be missing out on opportunities to reduce both your annual tax bill and lifelong tax liability.

For example, SIMPLE IRAs, SEP IRAs, and Solo 401(k)s are all offered to small business owners, and they provide tax-advantaged opportunities to save for retirement. Depending on your adjusted gross income, you may be eligible to contribute to Roth accounts as well, which can produce tax-free income in retirement.

Tax diversification is important for managing your tax obligations now and in retirement, and it’s another reason why business owners should consider strategically diversifying some capital away from their business. 

Retirement Preparedness

Right now, the Johnsons are depending on the sale of their business to fund the vast majority of their retirement.

But here’s the hard truth: It may not be enough, and depending on this one income source in retirement is risky (just remember, a recession could diminish the business’s value or risk the sale altogether).

Achieving clarity regarding their retirement income needs and the anticipated proceeds from a business transition is crucial for the Johnsons. Understanding potential discrepancies between these figures is a key element of financial planning, and engaging with an advisor can provide valuable insights in this process.

An advisor will help them address questions about their retirement regarding:

• Fixed income sources (like Social Security)
• Insurance needs (Medicare, long-term care, life insurance, etc.)
• Covering unexpected expenses (healthcare costs, moving, home repairs, etc.)
• Inflation and high interest rates
• Taxes
• Leaving a legacy

Building Wealth Beyond Your Business

By speaking to a knowledgeable financial advisor who understands the unique challenges (and rewards) of owning a business, the Johnsons will be able to continue growing Johnson Contractor Services while diversifying their wealth in a strategic and forward-focused way.

If you’re a business owner and wondering if there’s room to build greater tax efficiency and risk management into your financial landscape, we invite you to reach out to our team today. We can review your current situation and discuss opportunities to move forward in a more diversified and goal-oriented way.

Written by Julie Fortin in collaboration with Lexicon Advisor Marketing

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