The Importance of Converting Equity to Capital

Guy Baker By
Guy Baker

MBA, MSFS

 

  1. Introduction
  2. The Beginning
  3. Why have a business entity
  4. To Pass Through or not
  5. Closed Entities and Pass through entities
  6. The benefits of owning a closed entity
  7. The Three Circles of Wealth – The Common Denominator
  8. The Three Big Questions
  9. I. Creating and Retaining Value
  10. II. Keeping Superkeepers
  11. III. Exit Strategies
  12. Additional strategies to build and retain wealth
  13. Conclusion

 

The Beginning

Think back to when you first conceived your business concept – to when you first started to convert your dream into a business. How did you start? Most business owners tell us they turned their business into a separate entity because their attorney or CPA told them it was a smart thing to do. And perhaps it was. But now that you have been a business for several years, what have you done to leverage the value you have created into value for your own personal benefit?

Most owners answer this question by saying they have received a consistent salary and frequent bonuses throughout the years. But business is cyclical; it ebbs and flows. When it flows, compensation can be quite rewarding. But when it ebbs, you may be forced, like a lot of business owners, to put money back into the business, to take out a loan in your own name to provide liquidity or cut your own salary to make ends meet. This is a reality of business and many business owners have, at one time or another faced the reality of economic cycles.

Why did I write this booklet? To help business owners understand the relationship between the entity and their capital. And to show you how to convert equity into personal wealth you can use to gain financial independence. Too often, business owners fail to concentrate on wealth accumulation. They focus instead on building a successful business and figure the conversion will take care of itself. They get to the Red Zone by default, with no preparation, no plan and run the risk of a fumble of the worst magnitude. A Red Zone failure will cost significant tax dollars and often a reduced selling price

 

Please understand, this booklet is NOT meant to be a comprehensive discussion on various tax strategies or the full array of problems facing the business owner. Rather it is meant to give you a brief overview to help you start thinking. To help you identify ways you can create and preserve your wealth and to attract and retain superkeepers, (your key employees) who can help make your company a standalone business. (Read E-Myth by Michael Gerber).

Corporations have an intrinsic value beyond just the monthly paycheck you receive. Eventually you should be able to convert the value of your company’s equity into investment capital. When you accomplish this, you will be finally independent of your company’s financial statement. But until then, you are figuratively, a slave to the business cycle (Read Good to Great – Jim Collins).

Preparing For the Red Zone

Why is preparing for the Red Zone important? Every business owner will ultimately reach the point where they have to solve the Business Rubik’s Cube. There are three questions which rattle around in the mind of virtually every business owner:

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  1. How do I build value in my business?

  2. How do I attract and retain the superkeepers who will help me build this value? And how do I compensate them?
  3. And finally what are the ins and outs of creating an exit strategy? How do I extract myself from this business? How can I convert the Fair Market Value into retirement capital effectively and efficiently?

The Red Zone solutions can be complex. To be effective you have to convert a business into an enterprise. You must solve the superkeeper dilemma and the wealth accumulation Rubik’s Cube. These are issues every business owner either faces or ignores. But eventually, they will have no choice. If you don’t deal with these problems effectively, the only solution will be to liquidate the business. And what makes it more difficult, is the longer you wait to start Red Zone planning, the fewer good, ethical and economically sound solutions will exist. But even so, they do exist. The question will ultimately be, is time your ally or enemy? Do you have time on your side?

This booklet is hopefully the beginning of a process to help you identify possible solutions to these three primary Red Zone questions and will help you formulate a plan to “convert man at work to money at work.”

The following is a short discussion on the basic business tax entities and the tax treatment of each. I suggest you skip down to “The Three Circles of Wealth–The Common Denominator” if you are familiar with these tax principles. The following discussion is a simple review of the tax basics that drive wealth planning in a business.

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