by Katherine Fleischmann & Martin Roche, Russell Investments
Executive summary:
- Advisors who have business owners as clients need to adapt their discovery process and service plans to help these independent and resourceful investors. This is most important when the clients are selling their business to fulfil their retirement dreams.
- A trusted advisor can play a vital role helping business owner clients manage the windfall they receive when selling their business. A key consideration is the impact of taxes when receiving a lump sum of money.
- Life decisions and financial decisions are inextricably linked. We look at the case study of one couple who forgot to make that connection and the impact that had on them.
Who doesn’t love horses? The image of a wild, powerful stallion galloping freely across the plains is an integral part of U.S. mythology. The strength and versatility of horses—from pulling wagons and herding cattle to helping fight fires and carry soldiers into war—also make them creatures to admire.
So we can all probably understand the desire of a hardworking middle-aged couple to sell their regional trucking and transport company and fulfil their dream of owning a horse ranch. I don’t know about you, but the idea of spending my golden years watching those majestic beasts roaming around my property seems idyllic.
Sadly, the story of this couple can serve as a cautionary tale for business owners and advisors alike. While they found the right buyer for the right price for their business, they didn’t think to include their financial advisor in the discussions and their retirement plans didn’t quite work out the way they had hoped.
What value can advisors add for business owners and what steps can you as an advisor take now to avoid being left in the dark when your business owner clients make seismic life decisions that will inevitably have an impact on their finances?
Value of an advisor: being part of the conversation is key
The qualities that drive successful business owner clients are in many ways shared by successful financial advisors. You can bring a unique perspective, passion and some of the same ingenuity that resides in your mutual entrepreneurial spirit to your relationship with these clients. That’s what makes working with business owners as clients so challenging, but also fulfilling.
But first it takes trust and communication to ensure you are part of the conversation when clients move to the stage in their lives where they sell their business. Life decisions and financial decisions are inextricably linked, and you have a unique opportunity to help your clients better understand that connection.
Let’s look at how keeping their advisor in the dark caused our horse-loving couple’s dream to become less than the retirement they wanted.
A cautionary tale
After running their business for 30 years, the couple decided to purchase the horse ranch they always wanted. They found a buyer who aligned with their personal values and the $5 million sale price gave them the funds to launch the next stage of their lives—or so they thought. They worked with their lawyer on the sale, but they didn’t include their family accountant or financial advisor in the discussions.
Their financial advisor only learned of this change in their lives after they had already purchased a 40-acre horse ranch for $1.5 million in cash. After taxes, attorney fees and paying off their existing home, they were down to $1.5 million. Of course, this isn’t a bad sum for someone in their mid-50’s. But with sizable costs to run the ranch and other aspects of their retirement yet to be addressed, their dream purchase ended up causing financial and family hardship.
As an advisor, being brought into the most personal and important decisions your clients make doesn’t always happen naturally. What can you do to better understand what’s most important to your client and the decisions they’re likely facing? And how can you ensure you are a part of the conversation right from the beginning?
We suggest these three strategies can help:
- Bolster your discovery process
- Build a structure for your relationship
- Embrace the power of tax management
Let’s take a deeper dive into each of these, through the lens of the particular needs of business owners.
Bolster your discovery process
If the goal is to be part of the conversation on major decisions before they’re put into motion, you need to have a solid and established relationship and a framework for serious conversations. We’re talking about the types of conversations that are deeply personal and sometimes hard to have, but get to the heart of who, and what, your client is saving and investing for.
It may not be enough to simply ask your clients what they see for the future, where their family, lifestyle, health, etc. is concerned. These are likely to be self-reliant clients and they will probably need help to open the dialogue. Embracing an engaging process for discovery enhances your ability to help your client clearly define what’s most important to them and how that might impact their financial resources and plan going forward. The concept of discovery might feel very routine and common to your practice, but the framework for connecting to what clients value most is nuanced for business owner clients. A good discovery process helps prompt clients to the areas where you’ll focus your conversation. Our discovery process is centered around five core areas of your client’s life: Family & relationship management, health & wellness, career & retirement, lifestyle & leisure, and community & giving. The practice of prompting clients with topics in each of these key areas of life can provide insight into what’s important today, and what’s not.
Click image to enlarge
It may sound simple, but consider that clients sometimes don’t know what to bring up: either they assume you already know, or you assume you should know and therefore don’t ask. When it comes to clients who are accustomed to being independent decision-makers, this is particularly true and important to overcome if you’re going to be part of the conversation about your client’s plans.
Leave enough breathing room
For both you and your clients, there’s often a search for security following the sale and influx of cash. For your client, it’s likely very tempting to reinvest in something tangible—physical property, another business, something that feels familiar and safer than nebulous dollars in the bank or investment portfolio. For you as an advisor, helping clients to plan for the next phase of life, it is only natural to want to formalize your client’s goals with some structure, like creating a dependable income stream, or wealth preservation.
For the couple in our example, the sale of their business gave them the opportunity to realize their dream of owning a horse ranch. The challenge the couple realized later was that although they prioritized one dream, without thoughtful planning, they were then unable to fulfill their other goals, both for themselves and for their children. As an advisor, you have the unique ability to help acknowledge the immediate emotions and yet help clients take a more measured approach.
This challenge isn’t unique to these clients. Money is emotional, and a sudden windfall can create a host of confusing and sometimes conflicting feelings: exuberance, guilt, anxiety, fear or loss are just a few. Bear in mind, emotions are transitory, but the impact of decisions may not be.
It’s only natural as an advisor to want to formalize what your clients are expressing. Building in the safety of ongoing income, or assurances that legacy wishes are incorporated into the plan, are natural next steps to help clients formalize their goals. The challenge is, business owner clients like to control their own destiny, and crave flexibility and autonomy. The risk exists that your client will change their mind or their plans, and do so without having a conversation with you beforehand. In addition to embracing a solid discovery process, leaving enough breathing room can alleviate some of that natural hesitation on the part of your client to plan. There’s nothing wrong with creating a decision-free zone for a short period.
That said, some areas of your client’s plan require more immediate implementation and formal structure: their estate plan, and any special-needs trusts, or specific bequests.
Build a structure for your relationship
When you help someone realize their retirement goals, you become one of the most important people in their life. When you have a solid relationship, you can be the guide to help coordinate with the other professionals in your client’s network.
Consider formalizing your engagement by sharing your service model with your client—including setting expectations around communication and meetings. Formalizing your engagement means capturing the takeaways from your meetings and next steps for clients. In addition to helping you stay organized, using our popular client engagement roadmap as a guide for your conversation with clients can help clients better follow your recommendations, particularly when plans are complex.
Embrace the power of tax management
For many business owners, the sale of the business represents the single largest check that your client will ever cash. And with that, comes the reality of income and capital gains taxes. Part of your job as the advisor is to help make tax-smart decisions so that the client can fulfill as many of the amazing plans and dreams they have as possible.
It isn’t uncommon for owners to prioritize keeping money in their business out of necessity, particularly in the early years, which often means forgoing saving for retirement. It’s also common to realize your client did not have a well-defined retirement savings vehicle. True, there may be an SEP IRA or individual 401(k), but neither was likely funded to the degree that your client can depend on for meaningful retirement income.
The proceeds from the business now need to serve a lot of purposes. This windfall is generally non-qualified funds, and that means there is the ongoing erosion of taxes to consider. Beyond the initial tax payment, the proceeds that get invested can continue to generate capital gains taxes that leave your clients less in-pocket to work with. A tax-smart approach can help try to grow the value of what is left after tax.
Embracing tax management as an integral part of the investing process means actively managing assets to help clients keep more of what they make. Over the course of the years, managing for taxes can make a meaningful difference in assets retained, meaning more resources can potentially be available to fund your client’s goals and dreams.
Final thoughts
Small businesses have helped to build our economy and shape our identity as a country. That would not be possible without the innovative ideas, willingness to fail and unwavering determination of so many individuals. Out of the millions of small businesses in the United States, the majority are run by sole proprietors. Serving as a trusted advisor to these clients requires commitment, relationships built on trust and an appreciation of the mindset that’s made these clients successful.
For our ranch owners, their story and plan didn’t end with their not-so-dreamy, dream purchase. Their experience is not meant to be a lesson in right or wrong decision-making, rather an opportunity to remember how vitally important the role of a trusted advisor is to clients facing the realities of a windfall, where life decisions become financial commitments.
Other posts by Katherine Fleischmann & Martin Roche
First part of our windfall series
https://russellinvestments.com/us/blog/client-small-business-windfall
