Entrepreneurs are naturally risk-takers. You’ve most likely gone out on your own to start a business “x” number of years ago or have taken the risk of buying into and joining a business. You have mastered your craft, you are an expert in your industry, and you know how to navigate it to your benefit. And then you sell and transition out of your business hopefully leaving you with a very large lump of cash in your bank account. What do you do next?
In this episode, we discuss how to think through and evaluate your tolerance for risk after the sale of your business. You've worked your entire life up to this moment, learn how to protect what you've worked so hard for.
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"Hey everyone we are back with another episode and talking about risk today. Now there are many different forms of risk and I’ll assume that many of the business owners and entrepreneurs that listen to this podcast are risk-takers. That’s a fair assumption given that you’ve most likely gone out on your own to start a business “x” number of years ago or have taken the risk of buying into and joining a business."
"And then naturally as we get older we become more conservative. Not for everybody but for most people this is what happens in my experience. With business owners, many continue to be risk takers even later in life with their business because it’s what you live and breathe every single day. You have mastered your craft, you are an expert in your industry and you know how to navigate it to your benefit."
"And then you sell and transition out of your business hopefully leaving yourself with a very large lump of cash in your bank account. From high six figures to multiple millions sitting in your personal checking account. And this is where the game changes."
The question you need answered before selling your business.
"What do you do next? How do you go about thinking through what to do with this money? Now it is my hope that before you go about putting your business on the market, you have done the planning in advance and already know what you're going to do when you receive that bucket of money or at least have a good idea. One of the biggest variables to know is how much are you going to need after taxes from the sale of your business to support your lifestyle going forward. Because the last thing you want is to go ahead and put your business on the market, it sells, and after the taxes and fees are taken out, you discover you don’t have enough money to live on. Meaning you have to go back to work. That is the worst-case scenario. So do your personal financial planning beforehand."
The definition of risk tolerance along with an example.
"Ok so back to what do you do with this bucket of money that’s sitting in your bank account and how should you think about risk. You may have heard the term Risk Tolerance, which is the level of risk you are willing to take or what you think your comfort level is with seeing fluctuations in any market, stock market, or real estate, doesn’t matter."
"As an example, if I asked you on a scale of 1-10. 1 being you are 100% guaranteed to never lose any money and a 10 being you are going to Vegas and willing to put everything you got on “black”, where do you think you’d fall between 1 to 10? It’s a very easy way to get an idea of where someone thinks their risk tolerance is. So I’ve had people tell me they are an eight or nine, which means they are comfortable putting their money in more growth-oriented investments. They are comfortable taking a higher level of risk seeing their investment go up and down with the stock market."
"If you told me you were a two, then you are not comfortable with the big swings in the market and you prefer investment vehicles that are more steady and that don’t go up and down as much."
Why risk tolerance questionnaires don't work.
"Now here’s the problem with the risk tolerance approach and what I’ve found out over the years working with people on figuring this out with their money. Many people don’t know their true comfort level with risk until they are actually in it or have had an experience through a market cycle where they have seen their personal money drop significantly. I’ve had folks who told me they are a nine on the one to ten scale which means they thought they were aggressive and okay with risk, but when their investments significantly dropped, like when COVID was at its peak, they were so emotionally involved they wanted to sell out."
"So asking the 1-10 risk scale question or even taking a questionnaire to assess your risk level is almost useless."
The three risk tolerance buckets.
"The better way to think through this is to assign a timeline to three buckets. The first bucket is CASH which is short-term (1-2 years) and in an account that you can access very quickly and that won’t go down when the market goes down. Bucket 2 is INCOME with a time frame of 3-5 years usually invested in short-term investments that still grow but would not fluctuate nearly as much as the stock market. Bucket 3 is the Growth bucket which is greater than 5 years otherwise known as your long-term bucket which is usually in things like the stock market that will go up and down but over the long term statistically have a high chance of growing."
"When you think through it this way, you are assigning a role and purpose for each dollar you have. So rather than guessing what your risk tolerance is and investing your money to that guess, you assign portions of your dollars to the three risk buckets, with a specific purpose, and what you end up having is balanced exposure to all the risk levels. Conservative, Moderate, and Growth."
Why a growth bucket is needed in retirement.
"Now some people think when they go into retirement they cannot have any volatility and can’t afford to take any risks. And that’s simply not true. To make sure someone doesn’t outlive their money, to make sure they have the ability to live the lifestyle they desire, and not lose the value of their dollars to inflation, most of the time there needs to be a bucket with a goal for growth."
"I said this at the end of my last episode, get your planning done early before you go down the path of transitioning out of your business. Understanding what that next chapter of your life will look like personally and financially, will put you in the best position for business exit success."