Many clients have an interest in a small business or family business which likely plays a role in their financial and estate planning. That business may not only be the primary source of income for the client but will be a critical part of retirement funding as well. Unlike stocks and bonds and other typical investments, a business is generally not susceptible of a quick sale and when there are multiple owners, it can be even more difficult to work into a financial plan.
Recently, in the course of a client meeting, a question came up about the client’s sources of income and what expectations regarding income the client had over the next several years. This is a natural enough question to ask where a client is working and the financial plan depends, at least in part, on employment income. In this client’s case, the question took on an interesting twist because the client was employed in a family business and derived income from various entities connected to or a part of that business.
Previous generations had established the business and expanded it over the years. The client, along with other family members of his generation, had inherited interests in the entities comprising the business. As the fortunes of the various entities within the business waxed and waned, income received by the client likewise changed over time. This lack of consistency and predictability supplied a challenge to planning for this client. However, this was not the biggest challenge facing the client and the plan – the family had no idea what the various entities making up the family business were worth. Without that knowledge, there was no way to do planning for any family member who needed to liquidate their interest or a part of it due to a divorce, disability, death, bankruptcy or other event.
An essential first step to understanding the value of the family business and so the real value in the client’s hands for planning purposes is an independent professional appraisal of the entities making up the business. A part of that appraisal will address the liquidity of the entities and how the family could possibly turn some portion of them into cash to meet a future need. Certainly, the survival of the business would require a means for the other family members to buy out a departing member’s interest when required by, for example, death and taxes.
If, as is not uncommon in the case of a closely held business, there is not a great deal of liquidity – cash on hand – then there needs to be another way to access cash when it is needed. This might take the form of reciprocal life insurance policies on the key family members so the business could buy out the interest upon the death of one of them. Other techniques may apply to provide the desired liquidity for other events. However, to have this assurance and a useful plan, the client and the others involved in the family business need to understand the actual and realizable value of their primary asset. So if you depend on a family business as a part of your financial plan, make sure you know what it is worth and how you can access that value when needed.