It’s no surprise that a special bond exists between business owners and their creations. After all, it is their blood, sweat and tears that make the visions possible.
However, business owners often fail to grasp how much of their net worth is intertwined with their business. And in doing so, they neglect to treat their hard-earned fruits of labor as an investment.
“One of the important things for a business owner to ask is, ‘What percentage of my total net worth is represented by my business?’ Asking that question creates the recognition that his business constitutes the bulk of his personal net worth,” says Carl Pon, co-managing partner of Vicenti, Lloyd & Stutzman LLP.
Smart Business spoke with Pon about the importance of treating a business like an investment, how to determine a budget dedicated to investment management activities and how these expenditures should be used.
Why is it so important for business owners to treat their businesses like investments?It’s important because their business probably accounts for the bulk of their personal net worth. What we often find is that closely held business owners may have more than half of their net worth tied up in one particular investment, and this is in the form of their business. It’s critical to treat this half of their net worth just as they would the other parts of their net worth.
How do the investing habits of owners of closely held businesses typically differ from other investors?
Part of it is that they don’t actually view their business entity which is the biggest part of their invested net worth as an investment. They are more likely to treat it as a do-it-yourself project, whereas other individuals typically have professional management advice helping them with at least portions of their investable net worth.
How should business owners determine if they are effectively treating their business as an investment?
The first step would be to compare the return on investment that they’re actually getting from their business with the other alternative investments that they have such as real estate, stocks, bonds and retirement portfolios. One of the critical questions to ask is, ‘Am I spending my managerial time working in the business or am I working on the business?’
Over the long term, most exit plans require that business owners actually work themselves out of a job. This is important, because business owners often don’t want to continue being in management after someone else owns the company.
What percentage of a business’s value should be dedicated to investment management activities?
Some experts in this area suggest that if you have a company with a value of $20 million or less you should spend 1 percent to 2 percent of the value of the company on an annual basis for investment management activities. This is similar to professionally managed mutual funds where you’re probably paying 1 percent to 1.5 percent of the invested amount on an annual basis for investment management and oversight.
Once a budget for investment management has been set, how should it be used?
A number of possible expenditures can help enhance the value of the business or improve return on investment. These would include things like having annual or periodic appraisals determining what the market value of the business is, creating and updating buy-sell agreements, and purchasing life insurance or other policies on key people.
Another key component is to create or update an exit plan, which is a document that guides you through the process of how you are going to ultimately harvest the value that has been created in your business.
Lastly, it is a good idea to get an annual review with corporate counsel to make sure that legal issues are addressed in a timely fashion. This way you won’t find yourself trying to clean up legal skeletons in the closet at the same time that you’re trying to sell your business.
What type of service and performance standards should business owners expect from investment professionals?
The most important thing is to get a clear understanding of the scope of the work and the deliverable results that are going to be provided by the experts. This is to make sure that you’re getting adequate bang for the buck for these expenditures and that you’ll have a clear understanding of how they will help improve the long-term return on investment for your business.
CARL PON is co-managing partner of Vicenti, Lloyd & Stutzman LLP. Reach him at CPon@VLSLLP.com.