Nobody needs to be reminded about the aging population and its impending impact on our financial landscape. However, one aspect of this trend that receives relatively little attention is the amount of personal wealth that has been accrued within private enterprises and the implications of an owner’s need or desire to convert that body of wealth into cash or liquid investments. With more than 2.5 million owners of medium-sized businesses in Canada beginning to retire, an estimated $1.2 trillion in business assets is poised to change hands, the largest turnover of economic control in generations.

Despite the old cliché about a home being an individual’s biggest investment, where a personal business exists, it is often this asset that dominates the household balance sheet. It is not unusual for these companies to generate exceptional financial returns, which can sometimes exceed 20 percent per annum. Accordingly, this asset represents a tremendous opportunity to build an individual’s net worth but can also represent an enormous risk within their investment portfolio.

Adverse events—such as the loss of key clients or employees, a sudden change in the health of the owner, a deterioration in the economic environment, or shifts in the competitive landscape—happen more frequently than many owners would like to think and can have an extremely detrimental impact on the value of their business and their net worth.

These business risks are often manageable when individuals have adequate time and energy to recover, but they become a bigger problem in cases where there is a shorter investment horizon and relatively defined financial obligations.

Working with a client to assess and address these risks is an extremely challenging component of any advisor’s job, and it often touches upon personal issues that require the advisor to act more as a personal therapist than as a financial analyst. In particular, there are 10 key areas where an advisor can be of most help to clients:

1. Estimating the proceeds required to meet anticipated future lifestyle needs. One of the most important pieces of information for an owner to understand is whether the anticipated proceeds of a transaction would be sufficient to meet their foreseeable financial obligations. Surprisingly few individuals have a clear understanding of how much wealth is required to finance their retirement, but getting this information is a critical first step in determining the course of action that will best suit their needs.
2. Assessing risk tolerance. By examining a client’s current net worth and the magnitude of their future financial liabilities, an advisor can gain a better sense of their risk tolerance and whether their current portfolio (including business ownership) reflects that appetite for risk. For instance, it is not uncommon for a privately owned business to represent more than 50 percent of an individual’s net worth. This represents an enormous concentration of risk in one asset and may warrant better diversification, particularly where some or all of the business’ value is required to finance future liabilities. In cases like this, owners often hedge the risk by selling a portion of their ownership interest to the logical successor or by borrowing against their business assets to invest the proceeds in a more balanced portfolio.
3. Identifying and evaluating their options for liquidity. These can include raising new debt or equity from a variety of sources, a partial or total sale of shares or assets, and a staged transfer of ownership to family members or to the management team. Each of these options comes with its own opportunities and drawbacks and must be thoroughly considered before initiating any action. It is often extremely detrimental in terms of both time and money to pursue an option that ultimately won’t satisfy the owner’s objectives.
4. Estimating the likely proceeds of a transaction. This is a key step in determining whether a particular course of action will meet the client’s financial objectives. It is important to determine not only the proceeds of a transaction but also the annual income likely to be generated by those proceeds, going forward. This is often a very difficult task that requires the input of advisors who are intimately familiar with the market for similar businesses. Even with expert advice, the price received can vary widely, depending on the interested parties, the structure and terms of the deal sought, and the financial performance of the business leading up to the sale.

It is important for the client to clearly understand the likely proceeds under a variety of scenarios and to make a fully informed decision based upon their personal and financial objectives.

5. Evaluating timing. Sales of businesses are usually driven by a combination of internal and external factors. Investment advisors are uniquely positioned to understand both the personal and market-driven factors at play, and can objectively assess the relative merits of a transaction’s timing. That being said, in practice it is often impossible to accurately predict the optimal market environment for the sale of a business interest. Prudence would suggest that the business owner should strive to be in a position of constant readiness so that they can quickly react to unsolicited offers or changing personal priorities.
6. Lifestyle transition. Where the owner plays a reduced role in the post-transaction day-to-day operations of the business, the biggest hurdle is often grappling with the loss of personal identity and purpose which that employment provided. In my experience, this represents the single largest barrier to effective succession planning. If a client does not have a clear view of how their free time will be productively spent outside of the business, there is little chance a transition plan will work, regardless of the solid reasoning behind the plan.
7. Tax opportunities. Tremendous opportunities exist to minimize, eliminate, or defer the taxes owing upon the transition of a private company. Advisors will realize material savings for their clients in this area by anticipating and implementing the proper tax-planning strategies. Clients should be encouraged to act proactively to protect the value of their investment by seeking expert counsel on this issue. Some of the most lucrative of these opportunities (e.g., capital gains exemptions, family trust structures, etc.) can save owners hundreds of thousands, if not millions, in taxes, but they often require a considerable degree of foresight.
8. Pre-transaction planning. Aside from tax-planning initiatives, a number of other opportunities exist to significantly enhance the value of an enterprise through diligent preparation. Putting in place the proper corporate structures (e.g., family trusts, etc.), supportive management teams, and various “window dressing” strategies (such as an attractive modern website) can yield tremendous returns. A client’s ability to negotiate favourable terms will be a function of clearly understanding their alternatives and the length of time available to make a decision. Accordingly, it is important that business owners do not avoid these issues in the hopes that they will take care of themselves. Business owners who take the time to reflect and clearly identify their priorities in advance of an ownership transition (e.g., price received, family legacy, retention of employees, etc.) will more confidently be able to negotiate a deal that satisfies these objectives.
9. Assembling the team. Where additional advisory services are deemed necessary, the investment advisor is often a trusted source of advice regarding the most effective professionals for the job. Lawyers, tax experts, investment bankers, management consultants, and even personal counsellors can all play a role, depending on the nature of the transaction involved. In this regard, the world is full of consultants, and not all are created equal. Try to find supporting experts with a wealth of first-hand experience in the specific issues that you are facing and strong reputations for professional integrity. Advisors with both of these traits will prove their worth many times over before the process has concluded.
10. Advising the next generation. Where younger family members or the new management team have accepted greater responsibilities within the business, they will require a new set of financial skills to navigate the associated personal and corporate challenges. The incumbent wealth manager brings a critical level of knowledge, familiarity, and perspective to this task.

On top of all of this, it is important to understand that unexpected complications and detours occur in almost every process, and the business owner and his team must be able to respond confidently to these challenges.

Familiarity with, and objective advice on, each of these matters is an indispensable asset for Canada’s business owners. Those advisors who are best able to navigate these potentially complex issues are sure to stand out from the crowd and wisely protect their client’s net worth.

When Mr. Fairchild first entered the real estate industry, it was in its infancy as an institutional asset class, and it was dominated by real estate operators such as property managers and brokers who had little understanding of investment management. Looking out at an audience of CFA charterholders and other investment professionals who are either actively working in, or interested in, real estate portfolio management issues, he commented “how far this asset class has come.”