If you own a business and are thinking about selling, you've likely heard the advice to reinvest every dollar back into your company. While this can fuel growth, it may also expose you to significant concentration risk. In my 33 years advising owners, I've seen how keeping too much wealth tied up in one business can cost you dearly at exit.
Quick answer: Reinvesting every available dollar back into the business feels like the highest-return move, and often it is. But every dollar kept concentrated in the company is a dollar still exposed to that company's valuation swings, and it can become leverage a buyer uses against the owner at exit. A three-bucket test, operating capital, exit capital, family wealth, turns reinvestment from a reflex into a decision.
Why Does "Just Reinvest It" Sound Like the Right Answer?
The case for reinvestment, and where it stops being the whole answer
Reinvesting in your business is often seen as the best way to grow your wealth. The logic is simple: your business is your highest-returning asset. However, this approach overlooks the risks associated with having all your eggs in one basket. According to Kitces.com, having too much of a portfolio tied up in a single company leaves your overall wealth extremely susceptible to fluctuations in that company's stock price.
Why the advisory industry is building more infrastructure for this exact problem right now
The wealth advisory industry is actively expanding its capacity to help owners diversify out of concentrated positions. Recent moves, like Waterloo Capital's partnership with Bay Rivers Group, highlight the growing importance of coordinated tax planning and estate structuring for business owners.
What Does Concentration Actually Cost an Owner at Exit?
Why a single concentrated position is fragile
Concentration risk can make your financial position fragile. As Kitces.com notes, single concentrated stocks can create significant wealth but can also destroy it when held for too long.
How concentration becomes dependency, and dependency becomes lost negotiating leverage
When your wealth is tied up in your business, you become dependent on its success. This dependency can become a liability during exit negotiations. InvestmentNews highlights how markets can sense desperation, which can reduce value at precisely the moment owners are most dependent on the proceeds.
What Is the Three-Bucket Test?
Operating capital: what the business actually needs to run and grow
Operating capital is the money your business needs to function day-to-day. This includes payroll, inventory, and other essential expenses.
Exit capital: capital deliberately built toward a future transaction, not reinvested by default
Exit capital is money set aside for your eventual sale. It's about preparing for the future, not just reinvesting by default.
Family wealth: capital already diversified out and insulated from the business
Family wealth is the portion of your assets that are diversified and protected from business risks. This is designed to promote financial stability regardless of business performance.
What Does This Look Like in Practice?
A hypothetical illustration
Imagine two business owners, each with the same free cash flow. Owner A reinvests every dollar back into the business. Owner B applies the three-bucket test, allocating funds to operating capital, exit capital, and family wealth. Over several years, Owner B could hypothetically have an additional $500,000 in diversified wealth and a stronger negotiating position at exit. This is an illustrative example, not a projection or promise.
Frequently Asked Questions
Should I stop reinvesting in my business to diversify my wealth? Not necessarily. It's about balance. Consider using a three-bucket test to decide where each dollar should go. How much of my net worth should be tied up in my business? There's no one-size-fits-all answer. Evaluate your risk tolerance and long-term goals. How does concentration in my business affect my negotiating position when I sell? Concentration can make you dependent on the business, reducing your leverage in negotiations. What is the three-bucket test for business owner capital? It's a framework to allocate funds into operating capital, exit capital, and family wealth. When should I start diversifying wealth outside my business? Start as soon as possible to build a stable financial future.
Work with Pinnacle Wealth Advisory
If any of this applies to your business, it might be worth a conversation: Explore Exit Planning with Pinnacle Wealth Advisory
This blog post is for informational purposes only and does not constitute legal, tax, or financial advice. Consult with qualified professionals for guidance tailored to your specific situation. Doug may provide services and conduct business as Pinnacle Wealth Advisory with advisory services offered through SB Advisory, LLC. Doug Greenberg is an investment adviser representative of SB Advisory, LLC, a registered investment adviser. Results vary based on individual circumstances. Specific figures are illustrative, not guarantees of outcomes.
