What could be more exciting than to be a young entrepreneur? Millennial and Generation Z entrepreneurs are known for being innovative, bold, quick-thinking game changers. And if you consider the sheer number of new businesses fundamentally changing our business and technology landscape, they most certainly are.
However, what they are often not particularly good at is thinking about the long-term realities for themselves and their families. So much of their energy and passion is directed toward their start-ups and entrepreneurial ventures – the here and now – that too often they ignore the more mundane (but incredibly important) aspects of their personal financial situations and decisions regarding the ultimate fate of their businesses. What is the exit strategy? How can they leverage the value of their businesses? What happens to the business, and consequently their loved ones, if something were to “happen” to them?
Matt Teich, CFA, CFP, Director of Financial Planning for Cresset, says one of the worst things a young entrepreneur can do is put those decisions off. He argues that the best time to start thinking about an exit strategy, or what eventually will happen to a business, is when you launch it.
“It may sound cliché, but many millennial and Generation Z entrepreneurs think of themselves as immortal. If not literally, they think of these future realities as so far down the road that any sort of deep exploration is simply dismissed. That is a huge mistake,” he says.
To avoid that mistake, Teich offers the following four considerations that every young entrepreneur should explore sooner than later.
Establish a Will and Estate Plan
Younger people are notorious for not having a will or basic estate planning documents. There is a misguided belief that these are things you pursue when you are “older” or that you only need if and when you have children. Wrong on both accounts.
“If you are a young entrepreneur and you start a business and it’s having success, you absolutely need an estate plan, kids or no kids,” Teich says. “Think about it. Even if you don’t have a spouse or children, if something were to happen to you, what would happen to your business? Who would make the critical decisions that need to be made? Your parents? Maybe a sibling? Would they be equipped to do so? Or if you have business partners, is there an agreement in place for them to buy out your interest in the business? That all takes careful thought, consideration and planning.”
In addition to the usual components of a will or estate planning, such as having a health care directive and power of attorney in place, Teich advises that all young entrepreneurs with a successful business also have life insurance, whether they have a spouse and children or not.
“If you are a younger entrepreneur and you are relying on your business to generate the cash flow to live your life, if something were to happen to you, your family may very well need the payout from life insurance to live off of,” Teich says. “Even if you don’t have a spouse and kids, life insurance is important as whoever takes over the business on your behalf may need the money to pay any estate tax that is owed without having to resort to a ‘fire sale’. Or if you have business partners, they may need the money to buy out your portion of the business.”
Don’t Default to Being too Conservative in Your Investment Strategy
Among entrepreneurs and business owners, the old way of thinking related to investing in the markets was to be relatively conservative. The rationale was this: “Since I’m taking a lot of inherent risk with my business, I’ll balance that by being more conservative with my other investments.”
“That is a very dated way of thinking and not one that necessarily benefits the entrepreneur, especially younger ones,” Teich says. “It can in fact leave a lot of opportunity on the table.”
According to Teich, entrepreneurs can still think about their business assets as “aspirational” or risk assets. But if a business is generating adequate income and produces enough liquidity to live the life they want to live, then they can often afford to be more aggressive with non-business investments.
“As one client recently told me, let your lifestyle drive your investment strategy, don’t let your investment strategy drive your lifestyle,” Teich says.
Starting Thinking about Wealth Transfer
Young entrepreneurs launch a business to be successful. That’s a no-brainer. But what happens when they achieve that success? How can / should they leverage the fruits of their labor?
One of the questions young entrepreneurs should ask themselves is whether they really need to keep all of the ownership of their businesses for themselves as they become successful, or if it makes more sense to transfer a stake of the business to their children, a family member, or trusts in their names.
“Very rarely do young entrepreneurs thinking about wealth transfer,” Teich says. “Instead, they are thinking, ‘This business is worth a lot now so I’m going to sell it and use the money to fund my next idea.’ It’s a linear way of thinking that they believe they can just keep repeating. It’s more complex than that. Instead, they should be thinking, ‘How much do I need for myself, how much do I need for my next enterprise, and how much is left over to go to the people or causes I care about, such as a donor-advised fund or a private foundation?’ That’s how entrepreneurs can really set themselves and those they care about up for long-term success.”
Consider a Qualified Small Business Stock Exclusion
Finally, for those who are thinking about starting a business, consider early on whether organizing as a C-corporation makes sense. Doing so has traditionally been a non-starter for many entrepreneurs as up until recently it often meant higher taxes. However, among the changes in the tax law passed in 2017 is the permanent lowering of the corporate tax rate from 35 percent to 21 percent, which is causing even existing businesses to consider whether they should reorganize to a C-corporation.
Another benefit of doing so is that the business can take advantage of the Qualified Small Business Stock (QSBS) exclusion. Not every business qualifies, but for those that do, the QSBS exclusion can result in paying very little or no capital gain taxes when the business is eventually sold.
“This is one strategy that entrepreneurs should start working on right away,” Teich says, adding that he recommends exploring if a business, whether it exists yet or not, would qualify for the QSBS exclusion with a qualified advisory team.
“By exploring the strategies outlined above and investing some of the passion and energy they have for their businesses into estate and financial planning, millennials and Generation Z entrepreneurs can help set themselves, and their businesses, up for long-term success.
Matt Teich, CFA, CFP®
Director of Financial Planning
mteich@cressetcapital.com
312-429-2413
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