Wealth Management Insights

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Post-exit: investing for income?

One of our clients once described this transition as the difference between drawing from a river and drawing from a lake"

Selling a business is undoubtedly a huge moment for any business owner – a moment for celebration, and often the culmination of an entrepreneur’s career.

However, this will also mean a significant change for both their lifestyle and financial situation.

Though some buyers and industries will require founders to stay on with the business for an earn-out period (potentially multiple years), many owners will leave their roles shortly after the sale. This departure is often accompanied by a large cash sum, but also the loss of the regular salary or dividend that funded their day-to-day spending.

One of our clients once described this transition as the difference between drawing from a river and drawing from a lake - a perfect analogy in our view.

Where you previously received a regular and consistent income, you now have a ‘lake’ of newly acquired wealth.

This lake of wealth is a good problem to have, but a problem nonetheless. 

When the dust settles

So you’ve done it, you’ve made the sale. Now is the time to pause, think, and take the time to plan.

This liquidity event will represent a major shift, not only in your financial security but also in the lifestyles and opportunities open to you and your family. For some this means securing private education for their grandchildren, while for others it can mean splashing out on an aspirational asset such as a holiday home or a classic car.

Before any irreversible decisions are made, we encourage our clients to talk through their future plans with us so we can get an understanding of current, and expected, expenditure. We can then think about how to structure your finances to ensure you have sufficient cash to meet your day-to-day spending needs, and we can also make use of long-term cash flow forecasting to give a clearer picture of the years ahead.

What we mean when we talk about income

The world of investing can, at times, need its own dictionary (and there are quite a few out there). Income to the man or woman on the street often means something very different to that of a professional investor.

For many of our clients that have exited a business, we see that concerns around ‘income’ are something much more fundamental – I don’t have a salary, how am I going to pay for my lifestyle?

Therefore, when we talk about ‘income’ post-sale, we mean the money you need to cover your day-to-day spending requirements.

Legendary investor, Benjamin Graham, famously remarked that “In the short run, the stock market is a voting machine. Yet in the long run, it is a weighing machine”. In essence, he is telling us that in the long-run stock markets will recognise the true, intrinsic value of a business but in the short-term prices can swing based on investor sentiment and emotion. While these market movements are normal, it will mean that the value of an investment portfolio can fall, as well as rise.   

That is why, firstly, before investing our clients’ capital, we recommend that they keep aside 2-3 years’ worth of living expenses in cash as a buffer to protect against this market volatility and provide them with the certainty that the money will be there when they need it. Our clients can therefore avoid having to liquidate their portfolio for short-term cash needs, meaning their invested wealth can continue to accumulate returns and grow its real value over the long term.

In certain cases, we use our portfolio lending capabilities to support our clients' short-term cash flow needs.

Investing for income?

When investing to meet income targets, many wealth managers deploy capital to ‘income investments’, which may consist of assets like dividend-paying stocks and fixed income securities such as government or corporate bonds.

While this strategy can often mean a steady income stream, 2020 proved to be a difficult time for income seekers. In an environment of unprecedentedly low interest rates, and an economy-halting global pandemic, dividend-paying companies slashed, or even cancelled, dividend payments. The FTSE 100, for example, saw dividends paid to investors fall 44% to £61.9 billion.

Should you have been reliant on this kind of income in 2020, you may well have needed to liquidate part of your portfolio to meet your short-term spending requirements – simply, you would have become a forced seller.

For our clients, we don’t build their portfolios in this way. When we ‘invest for income’, we maintain our core investment approach; investing bottom-up in companies which we believe will grow sustainably ahead of inflation.

Unconstrained by having to find specific assets, we can significantly expand our investment universe and select the best companies and funds to help preserve and grow the value of your wealth over the long term.

By drawing capital from growth-oriented total-return portfolios, we can therefore help clients draw funds in the most tax-efficient way, as well as giving them far greater flexibility in the amount of ‘income’ they receive and how often they receive it.

Planning for your exit

All too often, entrepreneurs neglect their personal finances in pursuit of business growth, but it's never too early to seek the right advice.

If you would like to discuss any of the topics mentioned above, or to simply understand how we can support you and your business, please get in touch.

Client case study

Background

We recently created a financial plan for one of our clients following the sale of her healthcare business in 2021. This client was in her mid-50s, married with two children and living in the North West. Her husband was ready to stop working so last year they decided they wanted to enjoy their retirement together, and as a result that she would like to transition away from running the business.

Having discussed this new objective with the couple, we connected her with Rothschild & Co's lower-mid market specialists, Arrowpoint Advisory, who subsequently helped guide her through the business sale process. 

Making a financial plan

In the lead up to, and on the successful completion of this sale, we met regularly with the couple to discuss their financial plan. During this process, we analysed their current spending, outlined their post-sale objectives in greater depth, and used cashflow forecasting to understand how their spending requirements might change in the future.

Their objectives post-sale included:

  • Purchasing a £2 million dream house in the South of France
  • Gifting £500,000 to each of their children for them to purchase their first property
  • Investing £5 million into a friend's business venture
  • Enjoy having more free time and slower pace of life

We subsequently built a detailed model for their after-tax sale proceeds of £22 million.

This model took into account:

  1. Their immediate expenditures
  2. The likely cost of their new lifestyle
  3. Phasing of funds into a long-term nest egg portfolio
  4. The projected returns from their investment portfolio with us

After taking into account the purchase of the French property,  gifts to their children of £1 million total and investing into a new business venture, we recommended they put £13.5 million into this nest egg portfolio.

We then agreed on an annual 'income' of £200,000 (versus the £100,000 she had previously paid herself as a salary) in order to cover their elevated everyday costs.

We also recommended that they keep £500,000 in cash (2-3 years’ worth of spending). This cash buffer protects against market volatility while allowing us to look for opportunities to top up this buffer while we monitor their portfolio.

We have regular reviews and check ins with our client to discuss any changes we feel necessary based on their spending and investment plans.

Though this model was certainly not definitive, it gave the couple the confidence to commit to their purchases and other investments – before investing the remaining capital with us.

 

Source: Rothschild & Co, Bloomberg.

Image source: USGS, unsplash.com.

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Past performance is not a guide to future performance and nothing in this blog constitutes advice. Although the information and data herein are obtained from sources believed to be reliable, no representation or warranty, expressed or implied, is or will be made and, save in the case of fraud, no responsibility or liability is or will be accepted by Rothschild & Co Wealth Management UK Limited as to or in relation to the fairness, accuracy or completeness of this document or the information forming the basis of this document or for any reliance placed on this document by any person whatsoever. In particular, no representation or warranty is given as to the achievement or reasonableness of any future projections, targets, estimates or forecasts contained in this document. Furthermore, all opinions and data used in this document are subject to change without prior notice.

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