To sell or not to sell the business you built?

Many successful entrepreneurs have all their wealth tied up in their business. This probably makes sense at a time when they are building the company’s activities and have ultimate control over its destiny. But is that still true once they have stepped back to a lesser or greater extent from active involvement in its operations?

Investment theory insists that it is poor practice to keep all your financial assets in a single company. Businesses may find themselves subject to unexpected pressure, from new competitors or disruptive technology to extraordinary events such as the Covid-19 pandemic.

It is a huge risk to have all your wealth tied up in a single business, whatever your attachment to it. Instead, investment experts advocate that you should diversify your holdings across a range of companies, sectors and geographic regions. That way, if something goes wrong with a particular business or industry, its impact will be less than life-changing.

However, this is not the way most entrepreneurial business owners work. Their wealth is likely to be mostly or completely tied up in their own business, over which they have a great deal of control and can, to some degree, determine its success or failure. Many business owners are far more comfortable with this type of risk than they are with, for example, stock market investment, where there is also risk, but they have no control.

A question of control

The problem tends to become more acute when a business owner decides to step back from the company they have built up and therefore no longer enjoys that control, or it is significantly reduced. Should they continue to keep a substantial proportion of their wealth tied up in a company where, like a stock market investment, they have little influence on the outcome? There’s also the question of whether the executives now running the business want to manage it for a single or dominant large shareholder.

Perhaps the most important questions is how involved founders want to be in the company after they give up its day-to-day leadership.

Among the many questions that entrepreneurs in this position should ask themselves, perhaps the most important one is how involved founders want to be in the company after they give up its day-to-day leadership. Do they want to be an employee, a consultant, chairman or a director, or have other specific responsibilities? This may affect any decision on selling all or part of their ownership interest. Will any potential new owners wish to use the expertise of the founder, or would they prefer to take the business in a new direction?

Linked to that is the question of whether the founder still aims to keep benefiting financially from the business, or decides they would be better off using the proceeds of a sale to redeploy their wealth in a broader portfolio that can generate a regular income. If the business is in a high-risk sector, would they prefer to diversify their assets? Or do they have the ambition and determination to invest in building a new venture?

Influence versus diversification

There are advantages and disadvantages to selling a large stake in the business. The arguments for keeping it are that you built it and understand it – you know the risks, and will have more influence than if you were investing in a portfolio of publicly-traded investments. You are likely to have a say, even if only an informal one, on key appointments and strategic decisions, and will understand the products and the market, the risks and potential rewards.

However, the critical stumbling block is that your investments will not be diversified. Business owners generally take a lot of risk in the process of building up their wealth. In most cases, once they have stepped back from the business, they are likely to prefer to enjoy their wealth rather than worry about it.

Stepping back completely is always difficult and becomes even harder if you retain a large financial stake.

But stepping back completely is always difficult, and is even harder if you retain a large financial stake. There is a risk that you will remain closely focused on the business and its decision-making, risking friction with the new management team.

In addition, the business may not be able to provide you with the type of income you are looking for. Returns from small businesses in the form of dividends may be lumpy and unpredictable, and successful entrepreneurs may prefer the assurance of a steady income stream to support themselves and their families.

Taking it gradually

However, it is difficult to move away from a business that has been part of your life for many years. Of course, there’s no requirement to do it all in one go. Owners can sell part of their equity but retain a shareholding that they gradually reduce over time as they grow more comfortable with other ways to invest their wealth. Buyers may prefer it, too, since it brings the reassurance that the outgoing owner maintains a stake in the company’s ongoing success.

That gives founders time to shape their investment portfolio gradually around the priority areas in which they are most interested, or to build up their expertise in other sectors. There is a key role in such a process for a good investment manager, whether on a discretionary basis or otherwise, who can design a portfolio aligned with the client’s areas of interest and expertise.

Much will depend on the way in which the business is transferred, and the related expectations on all sides. If a company’s founder continues to hold an influential position, such as non-executive chair, they may be expected to keep a financial interest in the business – other investors might become nervous if they see a key insider reducing their exposure significantly.

If you choose to limit involvement to an advisory role, the incentive to retain a controlling or other substantial stake in the business is diminished.

However, if you choose to limit involvement to an advisory role, the incentive to retain a controlling or other substantial stake in the business is diminished.

Choose your purchaser

If you want to keep a residual stake and some influence in the business, it may be better to transfer equity to successors within the business or an employee ownership trust, rather than, for example, a private equity or venture capital firm, which may pay a higher price but will probably insist on running the company as it sees fit. If the business is being passed to other family members, the founder should be clear about the parameters of their involvement.

There are other ways of blurring the lines. The founder of a business could opt to retain ownership of the premises from which it operates and negotiate a leasing agreement. This could provide a steady income stream that is not wholly dependent upon on the performance of the business in the future.

It is always difficult to step away from a company you have spent much of your life building, but it is risky to keep a major financial stake without meaningful control over the direction of the business, and in the long term it may be inadvisable. However, a range of options exist for business owners to consider before they decide whether and how to step back from the company they created.

The arguments for keeping a business that you built and understand include that you know the risks and will have more influence on its performance than on a portfolio of publicly-traded investments, but the key risk is an ongoing lack of diversification.