Is your wealth too tied to your business?

Is your wealth too tied to your business?

Ann: Welcome to Building More Than Business, a podcast from First Citizens Wealth. Our show is about exploring how personal wealth and business wealth intersect—and what that means for the decisions you make every day.

I'm Ann Lucchesi, a certified financial planner, a certified equity professional and senior director here at First Citizens Wealth. I've spent my entire career advising founders through their personal wealth journeys, and I really love talking to entrepreneurs about the businesses they're building, about equity planning, liquidity strategies, tax efficiencies and of course wealth preservation. Today, I'm delighted to be joined by my co-host, Nerre Shuriah, for our inaugural episode. Nerre, tell us a little bit more about you.

Nerre: Thanks, Ann. It's nice to share this platform with you. I hope you're enjoying a beautiful San Francisco, and I'm coming from a very green north Raleigh at First Citizens headquarters in North Carolina. So you asked a little bit of my background. I'm a tax lawyer by training. I'm also a certified business exit consultant and a certified mergers and acquisitions advisor. So business transitions, complex financial planning—those are a focus for me and my team.

I'm the senior director of our financial and business planning capabilities here at First Citizens Wealth. Basically, we help business owners connect the dots between their personal goals and their company's future. So on the way, we focus on growing value, reducing risk and getting them ready for whatever's next—whether that's a sale, succession or just a more well-run company.

Ann: Wow. That's really amazing because I find so many business owners don't know where to go find advice. And I don't mean just the personal financial advice, but kind of that crossover into where it meets their business.

So today we're tackling a big question: Is too much of your wealth tied up in your business? For founders and entrepreneurs, their company isn't just what they do—it's who they are. It's the very essence of who they are. And so all of their wealth is tied up in it.

But when your future is so closely tied to the company you've built, it is worth asking, have you really thought through what this means to your personal financial future? Today, we'll talk about how to spot the risks early on, protect the money you've earned—and will earn through the business—and ultimately create a lot more options for whatever comes next.

Nerre: It's easy to see how this happens. An owner puts their heart into their business, and it feels like their net worth is growing with every milestone. Sometimes they can't turn it off. They're thinking or working 24/7. But unless you're keeping tabs on what's liquid, what's protected and what's transferable, you may not realize how much of your net worth is riding on just one part of your financial picture.

We have clients often worth millions, but all that equity is in one asset: their business. And of course, as you can imagine, that creates risk. With all their eggs in one basket, some additional factors creating opacity ups the ante even more.

Secondly, their personal and business finances are often tangled, making things harder at tax time. And during a liquidity crunch or when they're seeking loans, usually they're mixing up a lot of their personal expenses and having the business pay for it. That could be cars, airplanes or even hiring a family member that's not actually working in the business. That creates for a lot of intermingled difficulties. And lastly, it can also create increased liability when your personal and your business finances are commingled. So think—if an event happens in the business space, your liability can now extend into your personal assets and vice versa.

So a couple of real-world examples maybe will help drive home my point a little better. We worked one time with a couple, they had a business that they were running. They thought it was worth about $6 million, which is a good sum, and they planned to gift that business to their sons. So we offered to do an informal valuation for them.

So remember, it's not formal—it's informal. And that shouldn't give you an exact value but should at least ballpark it so you know what you're working with—and we know what we're working with—when we're giving them advice. And it turns out the business was worth closer to $12 million, which completely shifted their estate and wealth planning strategy.

Another example that I'd like to share. We have an owner whose personal expenses were covered by the business. He was worth well into the high tens of millions and asked us for a cash flow, which I was a little confused about, thinking, "He's worth so much money. Why would he need a cash flow?" But when we did that analysis, which really just tracks what income is coming in, what's going out, projecting it over time, it turned out that not only was his annual expenses $3 million, the business was covering another $4 million for him every year. So that kind of stopped us in our tracks in looking at exit plans and really just working on "How can we get him to a better spending plan?" So not knowing your income and outgoing money, that's a situation ripe for fraud and mistakes, and even led us to wonder, "Can he even afford to sell at that stage?"

Ann: Yeah, you bring up a couple of really good points. First thing is about that idea—the separation of business and personal expenses. You know, I was talking to a member of our team just the other day, and he was talking about a client that he had met who was thinking about selling their small business. And the small business, it turns out, sits on a piece of land that he personally owned, and of course was paying himself rent, but was paying under the market share. And the problem that occurs is if a buyer's looking at this is, "Hey, is that business really as valuable as it looks on paper if you're underpaying on rent and we're going to pay the appropriate amount?" So it was another one of those places where it seems like things were separate but in fact were kind of commingled and created some problems.

I think the second thing that you talked about that's just so critical is this idea of getting a sense of what the value of your company is because it changes the way you make decisions. Why is it so hard for owners of businesses to objectively assess what their business is worth?

Nerre: Owners are emotionally invested. So remember what I said before—their business is their baby. That kind of attachment makes it really hard to see things objectively. And when you think about the type of person who runs a business—an entrepreneur—they're somebody that's willing to take more risk than the average employee. And to do that, they're also more optimistic, they're seeing potential and sometimes not the actual reality. That's what makes them successful, but that's also what puts blinders on to the true reality of their business.

Many owners don't have any benchmarks or comparison points. They're focused in on what their company does and may not know what other companies or competitors are doing. And so, the way they're looking at their company could be entirely different than the way a buyer or investor is gonna view that company.

If you've done so much to get your company where it is—you've put all your time, blood, sweat and tears, so to speak, into it—you're looking back at the world you built, and that looks successful to you. So you're gonna assess a pretty high value or think it's worth a lot. But owners may not be aware that, while that's all good, buyers are looking at the future. They’re looking at the potential growth of that business and what could be done. For instance, AI, have you integrated that into your business model? So those things may not be on the owner's mind, and that's why they may not have a clear or objective vision about the value of their company.

Ann: Now, one of the things that we've kind of introduced in this conversation that you've talked about, is this sense of formal valuation and informal valuation. Of course, we're comfortable in thinking about what that means, but maybe you could explain to the audience what we're talking about with those two terms.

Nerre: So there is a difference between a formal and informal evaluation. And I mentioned it's a good place to start when you're beginning your planning with an informal valuation. So basically, that is having someone—an advisor typically—just give you a ballpark number for how much your business is worth. It's usually based on your company's financials, so it's not audited. It’s just purely how you're bookkeeping.

And it can be done in a number of ways. It can be based on a formula, for instance, EBITDA, which is a performance ratio. Sometimes that's used. It can be based on book value or any number of types of formulas that will help us come to an amount that the business could be worth. But remember, it's a ballpark number. It's not exact. It's not vetted, and you can't use it for anything that you would take as formal action. So gifting or valuations, you need to actually get a formal valuation.

So let's get into what a formal valuation is—that’s when you hire someone who's credentialed and independent of your company. So it can't be your CFO or maybe the CPA that you use all the time. Somebody who has valuation credentials to do a valuation of your company. And typically that costs quite a bit of money, could be as much as $20,000. But it's a snapshot in time, so you do get a formal valuation when you're ready to take some action—like there's a title change, you're making gifts or you want to justify a value with the IRS. Then a formal valuation is really important. And as you're familiar with, Ann, 409A valuations are often done fairly frequently. So in some cases, it's just done when you're going to take action. In other cases, it may be more frequent. Do you want to just explain a little bit about the 409A valuation?

Ann: Yeah, I think it's a great thing to bring up. 409A really is a part of a deferred-comp rule that shifted and really focused in on the idea that if you're granting equity of your company, that you can't just, you know, put your finger in the air and decide what the company's worth. You can't have that informal valuation, but you in fact have to go get a formal valuation done to say what this common stock of the company is worth so that you can use that basis in granting equity grants out to people.

And I frequently think about formal valuations tied to IRS things, right? "Gee, I'm going to have a stepped-up cost basis because someone passed away," or "I'm gifting stock for an estate."

I know for myself, right? When my parents passed away and they left a farm to all four of us children that we went out and got a formal valuation done and paid for that so that we would establish our new cost basis that would apply to our ownership in the farm.

But that is not the same as what we're talking about, a small business owner coming in and working with your team just to get a sense of what they're worth. That's an informal kind of valuation. And important to know that there's just a wide variation, right, between what market you're in, what industry you're in, what's going on. I mean, you and I both see how private equity oftentimes gets interested in a particular sector, and that changes the valuation. So it's really important to understand not only what your business is worth, but those value drivers, right, in the business and how you grow those.

So with all of that as a base, one of the questions that I get all of the time, and I'm sure you do too, Nerre, which is, "Hey, when's the right time to start thinking about my personal wealth? I don't have a lot of liquid personal wealth. My company's growing. Do I really need to spend time on that?" How would you answer that question?

Nerre: That's a top priority. I would say separate your business and personal financials as early as possible. Day one is ideal, but it's never too late. And here's a couple of reasons why.

Having a personal plan brings clarity to your business decisions, and vice versa. Let's say you're getting married. That's a personal event. You would think, "What would that have to do with my business?" But your marriage may hit, you know, a rough spot. What if you decide that you two are going to separate? That absolutely will impact how you run your business. And same for your co-owners. You may find yourself in business with one of their spouses should one of them suffer a premature death. So you have to make sure your plans are built for both sides, business and personal, and that they align and work together.

You want to look at investing extra cash flow in other assets. We have lots of traditional business owners where the minute they get some extra liquidity or cash flow, they're flowing it right back into the business to help it grow. And that's commendable. But remember how we started this discussion: Putting all your eggs in one basket creates a lot of risk. So looking at investing your extra cash flow in something that's protected, like an ERISA-based retirement plan, can offer you a lot of benefits. And those are things like a 401(k) or an IRA. They are heavily protected from creditors. I would suggest business owners get an informal valuation early.

Ann: Yeah, I 100% agree with you. There's almost no such thing as too early. You know, I'd rather have someone ask me a question early on than wait until they've made a decision and we could have helped them had we engaged with them earlier. In my line, where I'm working with innovation people, so often one of the first times I'm connecting with them is they might have an opportunity to take a little bit off the table on their path. And, you know, they don't know how much to take off, they really want to hold onto the business, it's a very difficult decision.

And I'll illustrate through an example. I was talking to a founder one day and he's like, "Well, you know, I have an opportunity to take some off the table. My wife is really anxious to buy a home, so what I'm going to do is I want to take just enough off the table, about $300,000 after taxes, so that I have enough for a down payment for a home in the Bay Area."

And I looked at him and I said, "Well, tell me a little bit about where you see your company going. If things go the way you think they're going to go, what your exit's going to look like, and how much you're going to have."

And as he went through it, he said, "Well, look, if everything kinda went the way I think, it'll probably be about 5 years and I'll have $100 million at the exit." And I said to him, "Well, so if you—instead of having $100 million at exit, if you ended up with, say, $90 million, would it have a meaningful impact on your life?" And his answer was, "Well, no. It wouldn't have a meaningful impact." And I said, "So what if taking a little bit more off the table today brings you from the $100 million to the $90 million, but how much is the impact if you take a million off the table today and you have a little extra money? So, yeah, you're buying the home, but now you can furnish the home and do all the other things and give you just a little space to breathe from a financial point of view."

And he was like, "Well, that would make a lot of difference, particularly to my wife, like it would just give us a lot of breathing room." I said, "Well, then what you ought to be thinking about is taking a little more now and worry a little less about what happens downstream." And what he did in the end was actually take off about double what I'd suggested off the table, but it really allowed him to feel really happy about the decision—and then really be all in again on continuing to grow the company. So it really made a big difference.

And so, in that theme, I just think it is so critical for you to work with an advisor who really understands both sides. They understand that you love your business, but they also really understand the impact it can have in making the right decisions around your personal financial planning along the way.

So if someone is listening today and thinking, "Hey, this sounds familiar. What's the one smart move I can make today?" What I would tell them is plan early, right? A great place to start is with that informal valuation we talked about. Find an advisor who can speak to both personal and business needs, right, not just someone who just wants to talk about your personal finances because that business is the alpha in your portfolio, and they really need to understand about it when they're giving you an objective picture of where you can go from here. So get the right expert involved at the right time.

Now, Nerre, you mentioned—I'm going to backtrack a little to something you said earlier—the couple that had the company and they thought it was worth $6 million and so they had a plan of action when the company was worth $6 million. They engaged with you and they found out, "Wow. We're actually worth $12 million." And it actually made them pivot and make some different decisions. Talk a little bit about what it did in that decision planning. What were the big differences as they thought this through?

Nerre: So for this couple, remember I said they were thinking of just gifting that business to their kids. But once they realized it was twice the value, they realized, "Hey, $12 million is a lot to gift to my kids, maybe a little too much." So they decided to sell to a third party. That was the new plan. And then with the proceeds maybe split off a portion to give to their kids, and the rest is something that they could live on. So again, this is a couple where the majority of their net worth was tied up in one asset. Because that asset is illiquid, it doesn't feel that they're as wealthy as they are, so they're not living according to those means.

Ann: Yeah, it really does shift your perspective when you have different options on the table because someone gave you a different picture.

That's it for today's episode of Building More Than Business. Whether you're just starting out or scaling something big, the takeaway is the same—the more intentionally you connect your business success to your personal goals, the more options you'll create for yourself, your family and your future.

Nerre: Your business is a huge part of your life, but so is your personal well-being, family goals and financial future, and they deserve just as much attention.

Ann: Thanks for listening to our first episode. I hope you'll stick with us as we dive deeper into strategies, stories and real conversations that matter to business owners. Subscribe on Apple Podcast, Spotify or YouTube Music. And if you liked what you heard, share it with someone who might find it valuable too. We'll see you next time.

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