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Why Illiquid Wealth is Valuable to Financial Advisors | Financial Advisors


Small business has long been said to be the backbone of the U.S. economy for its ability to create new jobs and spur job expansion. In fact, small business creates two-thirds of new jobs and employs 46.8% of the private workforce, according to 2021 Small Business Administration data. The COVID-19 pandemic hit small businesses hard, especially minority-owned businesses. However, many have rebounded and continue to grow.

Financial advisors often market to a niche of potential clients, and business owners are regularly cited as an optimal market. However, when advisors talk with a prospective client about their current investments, rarely do they discuss one of the largest allocations in the client’s portfolio – their ownership interest in the business itself. In doing so, they miss out on valuable advisory opportunities.

Most small business owners hold a significant portion of their wealth within the business. This type of wealth may have low to no liquidity unless it is sold, so the asset is considered to be illiquid. Financial planners can only charge their assets under management, or AUM, fees on liquid wealth, so they often ignore the elephant in the room. While the value of the business is typically the largest asset the business owner holds in his or her portfolio, it holds little interest for most financial advisors until the owner is ready to sell the business and experience a “liquidity event.” 

It is not unusual for a financial advisor to miss out on more than 50% of the client’s assets, for which the client needs help to manage and grow. Business owners may even reject using a financial planner at all because the business asset is so routinely ignored.

An astute financial advisor will discuss a business owner’s entire wealth profile, including illiquid wealth, far earlier in the process than when the business is sold. In doing so, the advisor can help the business owner increase the value of the business and keep risks across the entire portfolio in proportion to the client’s overall risk profile.

Here are some key steps a financial advisor can take today with a business owner to turn illiquid wealth into opportunity for both the client and the advisor:

  • Get a business valuation every year to understand how concentrated their portfolio is in illiquid wealth.
  • Begin a conversation about the return on investment of the business. Is the investment into the business returning profitably to the owner either through after-tax interim distributions and capital gains, or the appreciation in the value of the investment each year and over time? Does this compare favorably to industry benchmarks? Consider what steps can be taken to bring the business into greater alignment with its peers.
  • Discuss risk mitigation strategies to ensure that the business owner has sufficient liquidity to maintain their lifestyle should an adverse economic event, such as inflation or recession, impact their illiquid assets. 
  • Implement steps that will increase the business valuation each year, as well as ensure profitable activities. Both business owners and their financial advisors share a common practice of adding business services without ensuring that the additional overhead carries more profit to the bottom line. Sometimes, a financial advisor or a trusted business coach can help an owner streamline their services and create far better economics by offering less.
  • Craft a financial plan that seeks to replace the income generated from the business with passive investments in retirement. Additionally, if the business is profitable, a financial advisor working in tandem with a certified public accountant can increase after-tax distributions to enhance liquid investments.
  • Ensure that the financial planning process starts with the end in mind. Many business transitions do not live up to their fullest potential because the business owner has not planned for their next chapter after transitioning out. When the human component of a business transition is properly intertwined among the numbers, the business owner can complete the transaction feeling more fulfilled. This is key to referrals to other business owners, as well as confidently capturing the assets during the liquidity event.
  • When a small business includes multiple generations, planning tiers can help capture lifestyle opportunities that will vary between parent and child, due to the differing duration of their expected needs. 
  • Does the business have the necessary documents and risk strategies to handle unexpected changes? For example, has the firm determined what will happen in the event that one partner has a contentious divorce? What about death or disability? Does a sibling or second generation coming into the business change the management dynamics? Bringing legal, tax and insurance professionals into the conversation ensures each of these risks are considered and ultimately covered. 
  • Finally, has the business grown well beyond its early years? Many business owners have either attempted to self-manage their illiquid assets or have outgrown their early advisors. Introducing more advanced, vetted professionals to the team is important for both the business owner and the financial advisor to continually upgrade the advice received and given.

Advisors often view these steps as an antithesis to their goal of growing assets under management. However, a successful business that grows annually will often generate a a steady stream of planning fees, a significantly larger planning fee at transition and, ultimately, result in significant liquid assets to be integrated into the remainder of the portfolio. 

The advisor who understands the unique value of illiquidity can structure their own practice with a variety of fee structures that capture the value of the advice for the client. Different fee structures may be needed in addition to AUM, so the advisor will want to update their regulatory disclosures with any changes. Less discussed, but equally valuable, the client’s varying needs enable the advisor to increase their reach with their centers of influence teams, resulting in higher numbers of well-qualified referrals. 

Most importantly, financial advisors who consider an owner’s illiquid wealth will diversify their own illiquid wealth within their firms, while creating a more economically resilient path for their own ultimate transition.



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