How U.S. Business Owners Can Diversify Wealth Beyond Their Company

Building long-term wealth as a business owner has its advantages. A founder’s financial situation is directly tied to the performance of the company they created. Equity can account for the majority of a founder’s wealth, while all of their income, savings, and future financial plans depend entirely on the company’s success. This can be risky even if the company is successful.

Diversifying wealth does not mean completely removing funds from a successful company. It can mean slowly developing assets and liquidity outside of the business while retaining enough of a stake to maintain the business and prepare it for the future. Learning how to diversify wealth beyond business ownership is less about walking away from the company and more about building a financial cushion alongside it.

The best approach varies widely for U.S. business owners depending on factors such as the company’s stage, cash flow, business structure, personal financial situation, and long-term goals.

Why Business Owners Often Keep Most of Their Wealth in Their Company

Business Growth Requires Capital

Growing companies need a lot of capital. Many business owners will reinvest and not take profits. This capital is invested in the company to support growth through hiring new employees, purchasing more inventory, procuring company equipment, and other operations that promote growth.

That can be the right approach if there’s a significant opportunity for the company to create additional value. However, that can leave the owner’s wealth completely invested in the company. Although a private company may be “valuable on paper,” it’s a very different kind of value when compared to real cash and liquid investments for personal use.

Business Equity Can Create Concentration Risk

Having a large share of net worth in a specific company exposes a business owner to many types of risk. Market risk, liquidity risk, and even operational risk become interrelated. The loss of a key customer exposes the owner to cash flow and income risk. If a key operational risk event occurs while the company also faces valuation risk, it may need an equity infusion at a time when the owner can least afford it. Business owners eventually learn to balance company equity with personal financial assets.

Diversifying the Business Is Not the Same as Diversifying Personal Wealth

A business entity can serve a wide customer base. However, if the owner’s net worth is concentrated in one business, personal wealth remains concentrated.

Even if a software company serves customers in different industries, that customer base still flows through the corporate entity. The software company may be less reliant on a single customer, but the owner still has an equity stake in the business. Owners need to answer a different question when considering personal wealth diversification: How much do they have outside the business?

When Should a Business Owner Consider Diversifying Wealth?

There is no hard-and-fast rule. Typically, a business owner waits until the business constraints and the owner’s personal situation warrant it.

When the Business Has Stable Cash Flow

When a business has stable cash flow from a predictable revenue stream and adequate operating reserves, the business owner has greater flexibility to pursue wealth-building strategies. Capital should not be withdrawn from the business unless payroll, taxes, operations, debt, and planned investments have been accounted for.

When Personal Liquidity Is Limited

An owner with high net worth from a private business may have limited available financial resources. The creation of personal liquidity will provide cash to address emergency needs or finance family expenses while the business requires a lower cash outlay.

When the Business Represents Most of the Owner’s Net Worth

The more the owner has concentrated wealth in one business, the more at risk the owner is from problems related to that business. Owners should regularly assess how much wealth they have concentrated in a single business, as they cannot assume that ongoing business success automatically builds a diversified personal wealth pyramid.

Ways U.S. Business Owners Can Build Wealth Outside Their Company

With adequate working capital and reserves, an owner can begin building assets beyond the business.
This will depend on the individual’s risk tolerance, goals, and available time horizon.

Public Investments

Stock ownership provides exposure to other companies that the owner doesn’t work for. Rather than having to locate potential buyers, publicly traded stock is easily bought and sold through a broker. Understanding the intricacies of the U.S. system is important for entrepreneurs who are international investors. While considering potential U.S. investments, foreign business owners should analyze the taxes, reports, and regulations relevant to the ownership interest.

Real Estate

Another avenue of possible diversification that investors may want to consider is real estate. Residential or commercial property in a market outside the owner’s business location could be worth considering. Rental property may generate additional income, but it will require time and money for property management and may also result in time costs for the owner, including maintenance and periods of vacancy.

Diversification from a single real estate property will also depend on the specifics of that property. For example, owning the real estate occupied by your business may not give the same diversification value as owning property with unrelated tenants and unrelated real estate markets.

Cash and Liquid Reserves

Even if the assets outside the business are not considered investments, their liquidity can be very important. Having unrestricted, usable liquid resources may help an owner meet their obligations when the business is not in an optimal state. This can be most useful for unpredictable income streams.

Precious Metals and Other Alternative Assets

Some business owners may consider alternative assets as part of a broader diversification strategy. Precious metals can provide exposure to an asset class outside the business, although their prices can fluctuate and physical metals may involve storage, insurance, and transaction costs. Unlike stocks, bonds, or rental property, precious metals generally do not generate ongoing income.

Gold remains a popular choice for investors seeking to diversify beyond traditional financial assets. From physical gold coins to other forms of bullion, gold has become a mainstay of American bullion investing, offering investors another asset class to consider alongside stocks, bonds, and other investments.

Precious metals should be viewed as one component of a diversified financial plan rather than a replacement for business capital, personal cash reserves, or other investments.

How Business Structure Can Affect Wealth Planning

How you organize your business can affect how your finances are divided between your firm and yourself.

LLC Owners

LLC owners must diligently separate personal and business finances. Business expenses should never be mixed into company funds without the proper accounting measures. LLC owners must also understand their LLC’s profits, distributions, and taxes.

Corporation Owners

Moving funds from a corporation to the owner involves a multitude of considerations. The tax and accounting implications of compensation, dividends, distributions, and other corporate transactions often depend on the particular facts and circumstances of the corporate entity. Owners should avoid the de facto mixing of corporate and personal funds.

Non-U.S. Owners of U.S. Businesses

Foreign entrepreneurs who own U.S.-based businesses may need to consider U.S.-based tax filing, financial, and reporting obligations. Business structures can change how the rules of personal and business finances are applied. Because the application of these rules can vary significantly based on the business owner’s country of residence, type of income, and business structure, foreign business owners should obtain proper tax and financial advice before making substantial changes.

Don’t Let Diversification Weaken the Business

Though concentrating wealth in a single business is a risky proposition, withdrawing too much capital from a business can create its own issues. Starting a successful business often brings opportunities that require capital expenditures. Funds used to hire employees, buy equipment, enter new markets, or create new products may create more economic value over the long term than investing those funds outside the business. The key to success is finding the right balance.

The owner may wish to determine the funding required to run the business day-to-day and grow it as intended in the near future. Funds in excess of this amount may provide the owner with an opportunity to create personal wealth outside of the business. Diversification should occur without endangering the business’s financial stability.

Keeping Business and Personal Finances Organized

The clearer an owner keeps financial records in separating business funds from personal funds, the better the diversification strategy tends to be. Personal financial accounts must be separate from business financial accounts. Business expenses must be kept separate from the owner’s personal expenses. The business’s financial records must be maintained.

Quality bookkeeping can help determine a business’s cash balance once taxes, liabilities, and expenses are accounted for and future obligations are considered. Tax implications are important and must be considered. There may be tax consequences of distributing funds from the business to the owner. Significant changes in the business may also result in considerable tax consequences. Events that warrant consultation with a professional should be carefully evaluated.

Nonresident aliens engaging in business in the U.S. should be aware that there are obligations that may require additional reporting. More than likely, they should engage in business in the U.S. only if they are in good financial standing.

A Simple Framework for Evaluating Your Financial Concentration

Business owners can periodically ask themselves a few basic questions at regular intervals:

• What percentage of my total net worth is in the company?
• How much of my personal liquidity is not invested in the company?
• Could I cover personal expenses without promptly involving the company?
• Would an industry contraction impact most of my financial assets?
• Does the company have cash to cover expenses and pursue growth?
• Is my long-term liquidity and retirement solely dependent on the future sale of the business?

Again, these questions do not provide an investment equation; rather, they allow the entrepreneur to position him/herself with respect to financial concentration.

Finding the Right Balance

A healthy company is very likely one of the most important assets in an entrepreneur’s financial assets. There is no need to walk away from the business or to not invest in available opportunities which can highly (not minimally) support growth. Investing outside the business does not mean losing the capital needed to run the business or pursue available growth opportunities. The right balance will depend on several factors: the number of companies already operating, cash flows, the tax situation, the goal, and the entrepreneur’s financial condition.

Instead of adhering to a fixed percentage or investment rule when putting together their financial plans, executives should consider how diversification might benefit their business. Such diversification could be built by each executive separately, allowing them to personally pursue wealth outside the business. As the business grows, the executives could continue to pursue their previously set separate financial goals.