Liquidity planning for business owners should begin well before any business sale transaction is considered. Unfortunately, for many business owners, the first time they think about building accessible liquidity is when an offer is being made to purchase their business, or a life event occurs that forces a change of ownership.

The blind spot of this type of financial planning is not limited to the first generation, but it is something we see in even mature, generational businesses. The type of liquidity is equally important to the planning for liquidity because the approach to building liquid assets for a future exit is different than building up available monies for growth of current and future illiquid assets.

When we think about business ownership, most imagine one of the archetypes of the “American Dream.” It provides independence, control over time and impact, and most importantly, wealth.

The self-made persona drives many to pursue this dream, and for those who achieve success, the significant emotional and financial risk is rarely highlighted. The less glamorous traits of being a “self-made person” fuel the habits that create greater financial planning issues in the future.

Business owners get desensitized to the amount of risk they are comfortable taking, and this becomes truer the more successful someone becomes. In addition to the desensitization, there is generally a bifurcation of comfort with risk someone can control and risk they cannot control. An example of this is the comfortability of investing significantly in one’s business but being uncomfortable with a small investment in the capital markets, e.g. the stock market.

Over time, the diversification of assets tends to shift toward other illiquid investments that provide the same sensation of control as the business, and life is good. The net worth statement looks strong, and the overall cash flow is steady and growing.

In this situation, what generally happens next? Lifestyle begins to grow. The cash flow may move into cash or cash equivalent investment types to be redeployed to other illiquid investments.

Depending on the business type, lifestyle spending might find a way to be routed through the business and provide tax advantages.

At this stage, a missed opportunity is growing as time passes that can significantly impact future flexibility on both an exit and an ownership transition.

After years of success and growing the business, it is time to exit. The owner might be first generation or third-plus generation, but it is time to liquidate. They have other projects that are generating cash flow, and they have a dollar amount in mind that is needed to supplement their lifestyle – the net number needed to sell the company for.

At this point, the owner is hoping the time, money and emotion they have put into this business has paid off, and the acquirer sees as much value as they do.

Unfortunately, in most cases, the owner/operator values their business more highly than most acquirers. In fact, we see more “bait and switches” occur on the open market when the initial offer amount is significantly higher than the final offer after due diligence.

When this happens, as it does time and time again, the owner is working to calculate how to unwind their lifestyle from the company, and the overall cash flow needs may not be fully supplemented by the final after-tax sale value or their other sources of income.

One of two things follows in these situations: the sale does not go through, or lifestyle must shift to accommodate a reduced sale figure.

In the situation that the sale does not occur, the owner is then forced to evaluate something they should have started years ago, which is liquidity planning through the investment in the capital markets. If lifestyle must shift to accommodate a reduced sale figure, the years of hard work and sacrifice might not feel worth it.

Addressing this blind spot early with a committed, serious approach can provide better outcomes. The level of planning needed is dependent on the maturity of the business, and a financial professional with specific experience helping business owners navigate this type of liquidity planning is key. 

Consider working with a fiduciary wealth advisor who can develop a plan that grows with the business and its owner’s overall goals so that, when an inflection point is reached, there are greater options and flexibility around whatever exit decision is ultimately made. 

Matthew Petersen is the director of advisor services and a senior wealth advisor at Petersen Hastings Wealth Advisors in Kennewick.