Three Stages of a Small Business Lifecycle and How to Prepare for Them

The American College of Financial Services
March 3, 2020

Starting and maintaining a small business, as well as supporting one, can be a daunting task at the best of times. In many ways, the lifecycle of a small business is similar to the life journey of an individual: a birth is involved, the creation of something new that didn’t exist before; then growth and maturity, where a child becomes an adult and learns to walk, run, speak, express themselves, and contribute to society; and then old age, where the business either needs to take a step back or make some significant changes in order to keep moving forward. And as a financial advisor, there are things you can do to ensure that for your clients and the small businesses they’re invested in, this corporate lifecycle goes as smoothly as possible.

Steve Parrish, co-director of the New York Life Center for Retirement Income and adjunct professor of advanced planning at The American College of Financial Services, has been advising clients about investments for years and provides his take on the three stages of a small business’s life.


BIRTH: What it Takes to Make a Startup Thrive


The history of business abounds with tales of people who made it big by betting on an unknown company with an uncertain future and sticking with it as it grew into an unstoppable corporate machine. Alternatively, there are just as many stories of participants in startups who got nervous and bailed too early or opted for easy money and got short-changed--or just didn’t know when to cut and run. Parrish says the key to fostering a successful startup business is a combination of guts, perseverance, and good luck, and there’s a limited number of ways your clients can get in on the ground floor of a small business aside from being a member of the family or a partner in the venture.

One of those ways, Parrish says, is for your higher-net-worth clients to be professional angel investors. “While venture capital is flooding the markets, a lot of that capital is coming from hedge funds, private equity and institutional investors,” he says. But even if a client is on a budget and wants to try supporting a startup, there are ways to do it. “You might have an opportunity to partner with someone with a vision but in need of a business partner to bring ideas to life,” says Parrish. “For every Steve Jobs, there’s a Steve Wozniak. For every Bill Gates, a Paul Allen. Often the successful silent partner simply started as the behind-the-scenes Yin to the publicity-grabbing Yang. These individuals weren’t so much investors as quiet founders.”

Parrish also counsels potential investors and their advisors not to focus on immediate payoffs and dividends, instead pointing to stock options as a more logical long-term investment in a company’s future. He also urges caution in considering legal liability and how much money a client is willing to lose, but as with anything else, bigger rewards are reaped by those prepared to take a little risk.


MATURITY: Doing Right by Yourself and Others


As a small business grows and hopefully flourishes, Parrish says two major points need to be considered: the first being taxes. No one really likes dealing with tax, but just like a growing person, a growing business has to eat its vegetables. As someone trying to make ends meet in a startup business or an investor involved in keeping one afloat, it can be difficult to tell what kinds of tax schemes have good results, and which are too good to be true. But that distinction, Parish notes, is one advisors need to pay particular attention to when considering investments in a small business.

Some of these lessons are self-explanatory: don’t write off personal spending as business expenses just because you want a break on your taxes (it’s illegal and can get you in big trouble). Avoid pitfalls in the guise of opportunities, including attempting to leverage life insurance past its intended benefits. Additionally, advisors should be aware of their own liability if they give clients advice that’s less than solid, as Parish notes recent court cases have punished accounting firms for aggressive tax planning strategies that backfired on businesses. And bad tax decisions can lead to a host of other poor business choices. As a responsible advisor, ensure you stop these destructive chains of events before they start.

The second point to be conscious of when advising about a small business is that business’s employees. How are they treated? What rights do they have? Are they invested in the company’s future? The legal definition of who qualifies as an employee and what benefits they’re entitled to is a fight that’s changed and evolved over the decades and likely won’t stop anytime soon. Parrish says a critical part of a successful small business is happy employees, and that doesn’t just mean paying them well. “Particularly with key employees, incentive plans need to provide tangible motivation,” he says. “Rather than just receiving stock certificates whose value is controlled by the owner, employees want to see actual retirement accounts. They want real benefits and easy tools to understand and access these programs.”


TWILIGHT: To Hand Off, or to Pass Off?


It’s an unfortunate truth that even if a client starts a small business, they won’t be able to hold onto it forever. At some point in people’s lives, they’ll want to move on and divest themselves of active responsibility for what they’ve created. Running a business is difficult, and with retirement on consumers’ minds more and more these days, the question of how to pass the baton without dropping it completely can be a challenging one.

According to Parrish, there are two choices for the small business owner: to sell, or to pass on the business to another person or family member. If it’s the former, Parrish says there’s a number of options to consider if a client wants to convert their business into a revenue stream that’s not an active part of their life, but will last them through their retirement years, including self-cancelling installment notes (SCINs), private annuity sales, Employee Stock Ownership Plans (ESOPs), and Social Security “file and suspend” strategies--all of which require complex financial knowledge and skilled advising to take advantage of.

If a client wants to take door number two and pass on the business, Parrish says there are still plenty of financial considerations to take into account. He details a scenario where a mother and small business owner wants to hand off her company to a son who is very involved, but the mother dies before all financial obligations have been taken care of and her children--even others who aren’t involved with the business--get stuck with the bill due to complex capital gains and estate tax laws. “The sale of a family business to a child while the parent is alive is often an advisable business continuation strategy,” Parrish says. “Just be sure to structure it carefully. Attention to detail will help avoid adverse financial and familial outcomes.” As an advisor, making sure you’re well-versed in all these areas can pay off in spades when handling a client’s decisions to invest in or take action toward a small business they have a stake in.