Three roads to wealth

(FORTUNE Small Business) -- As surely as seasons change, entrepreneurs face a new personal finance challenge at every turn, whether it's a sudden cash flow squeeze or a hike in taxes. And with stocks now wobbly, the path to wealth may seem less certain than ever. That's why FSB recruited expert financial advisors to give custom-tailored advice to three busy entrepreneurs: one who owns a budding apparel company, another who runs a successful mortgage business, and a third who has just cashed out and is now considering his options. Here are some financial tips, including the latest on new tax laws and strategies, to help you make the most of life's seasons.

Quinn Thompson launched his women's fashion label, Saint Grace (saintgrace.com), with $1,000, one type of fabric, and a vision to change the fit and feel of the T-shirt. Over the past six years his luxurious vintage-inspired knitwear company has grown each season with new styles, new customers - and new debt.

Thompson, 37, who has started businesses since he was 10 years old, self-financed Saint Grace with small lines of credit and big sums on his charge card. "I'm old school," he says. "I didn't know how to get investors." Although he was steadily growing the Los Angeles-based brand and consistently shipping product, the 90 to 120 days in turnaround time from raw fabric purchase to end - customer payment created constant cash flow problems. Thompson applied for small-business loans but was repeatedly turned down. "Banks don't like people who don't own a home," he says. "The reality is that you come into different cash flow crunches, and your credit card may be your best friend." By 2005, Thompson carried $175,000 in debt on his cards and owed another $50,000 on a family loan. "There were some pretty dark times," he says.

Everything changed, seemingly overnight, when Jessica Simpson ("a hot property at the time," he notes) was spotted sporting a pair of Saint Grace pants. Suddenly "we were making that product as fast as we could," says Thompson. By the end of 2005, Saint Grace was doing 50% of its business in those pants, and Thompson paid off all his debt. He was able to boost his salary from about $25,000 annually to more than $100,000. He also was able to buy his own home - a duplex condominium, part of which he rents out, earning additional revenue to help pay his mortgage and taxes, which run about $4,200 a month. Last year Saint Grace, which has attracted additional celebrity fans including Angelina Jolie, Jessica Alba, and Drew Barrymore, was carried in more than 500 boutiques nationwide and did $2.6 million in sales.

As the owner of a new, aggressively growing business, Thompson says he's primarily focused on investing in Saint Grace rather than socking money away in illiquid retirement accounts. ("This is my retirement," he says of Saint Grace. "It's easier to have more confidence when you're driving the ship than when someone else is in charge.") So far Thompson has been able to cull about $26,000 in retirement savings, split between an IRA that resulted from a rolled-over 401(k) and a SEP IRA, to which he contributes $200 every month.

Thompson is in the process of selling a different clothing company he co-founded around the same time as Saint Grace, a denim brand called Reo Starr. The deal is expected to bring him stock in the new company and a consulting salary.

Looking ahead, Thompson's goal is to build his liquidity so that he has the flexibility to grow his business by launching new divisions or investing in new technology. He says that he's always able to pay his bills and his employees, but "there's not a whole lot left." On a personal level, he'd also like to be able to accumulate more wealth to invest in additional income properties. Thompson has never worked with a planner. "I've kind of been winging it," he says. "I don't have any real direction beyond what my garment industry accountant tells me." He's concerned with how to balance his business's need for cash with his personal need to adequately fund retirement.

Smith Barney financial advisors Mark Bradburn, a vice president of wealth management, and his brother Jason Bradburn, a certified financial planner - the two work as a team within Smith Barney (smithbarney.com) - say that Thompson's first step should be to develop a strategy to build personal liquidity so that he can eventually fund investments such as rental property or new lines of business. To get started, the Bradburns suggest that Thompson create a budget and savings plan. To do this, he first needs to determine how much he spends every month, both personally and at Saint Grace. "I never had a budget - ever," admits Thompson.

The Bradburns add that it's time to apply a more structured approach to the business's finances. "Almost all entrepreneurs rely on personal credit cards in the beginning," says Jason Bradburn. "Now the business is clearly growing. You can build liquidity, and you can get lines of credit from a bank." Bradburn explains that Thompson can also get loans based on the stock he receives from the sale of Reo Starr.

As far as retirement savings, Mark Bradburn commends Thompson on contributing to his SEP IRA every month ("it takes advantage of tax-deferred compounding"), but adds that he'd like to see more of a nest egg. Instead of going through with plans to buy more property and put a pool in his backyard, Bradburn advises, Thompson should prioritize building liquid investments and retirement accounts. "Take a breath. Once the business takes off you can buy the block and put a pool in everyone's yard," says Bradburn. "But first we need to see more money in the bank so you don't feel so strapped."

Jason Bradburn agrees with Thompson that he has no current need for life insurance since he has no dependents, but adds that he should consider a living will to deal with any unforeseen end-of-life issues. Thompson, who frequently rides his two motorcycles and recently began amateur car racing in his Porsche, admits it's a good idea. Says Jason Bradburn: "We need to protect you from yourself."

Overall, Thompson embraces the Bradburns' recommendations. He says he has already started on a budget and is looking forward to reconfiguring his personal finances to be in sync with his business goals: growing Saint Grace to $10 million to $20 million in annual sales and expanding internationally. "In the past four or five years I've done what I've had to to survive," says Thompson. "Now I need to structure for the future."

STARTING OUT

Experts Mark Bradburn and Jason Bradburn of Smith Barney advise Thompson to:

Build bank credit lines.

Create monthly budget.

Delay illiquid investments, such as property.

David Zugheri is one goal-oriented guy. In 1997, when he was 27, he cashed in his retirement savings ($4,000) and co-founded his business, First Houston Mortgage (firsthouston.com). The firm was profitable within a month. Next, Zugheri designed a plan to save $100,000 in cash and stock by age 30 and to comfortably retire by 35. By working long days (often spending all night in the office) and scrimping to extreme (he lived on ramen noodles), Zugheri reached the $100,000 goal by the time he was 28. Then, thanks to savvy investing, he increased that sum to $280,000 one year later.

But his race to wealth hit a wall in March 1999 when the Internet bubble burst and he lost his entire portfolio in two weeks. (He even needed to wire an extra $10,000 into his brokerage account to cover losses related to a margin call.) "After that I realized the only way to get rich was one day at a time," says Zugheri. He also changed his philosophy on investing: "Why should I invest in a company if I don't even know what it does? Why not invest that money in myself?"

With that epiphany, Zugheri abandoned his plan to retire at age 35 and refocused his energies on building First Houston. The company, now ten years old, has 70 employees and does about $8 million in revenue annually. It recently opened new offices in Arizona, and Zugheri, 36, expects to go national in the next five years.

Zugheri now has several million in liquid cash in the business, yet he and his business partner, Dana Gompers, each take average salaries of just $100,000; Zugheri wants to ensure that First Houston maintains adequate liquidity - both to fund its growth and to qualify for lines of credit. At the same time he's concerned about paying for personal needs, including private school for his daughter, Mia, 6. He also wants to ensure that he earns enough to allow his wife, Adrienne, to continue as a stay-at-home mom, and to save for the future.

"The worst thing about being a business owner is that you're worth a lot on paper, but cash flow is tight," says Mark Nash, a personal financial services partner at PricewaterhouseCoopers who works with high-net-worth individuals and closely held businesses. Nash suggests that when the business generates excess cash, Zugheri and his partner should take extra compensation to build wealth outside the company. "The place to stockpile is not in the business; it's in other savings vehicles," Nash says. His reason: Moving money into investments outside the business will protect Zugheri's assets in the event of a lawsuit against the company. It will also help diversify his portfolio, lowering his risk.

Nash is pleased to learn that Zugheri's only debt is his mortgage ($2,300 a month, which includes taxes and insurance) and a small car loan. He also says Zugheri is on track with retirement savings of about $155,000 and a well-mapped plan to save more. First Houston recently established a matching 401(k) plan, which Zugheri maxes out, contributing about $20,000 a year. Last year he also opened a variable universal life (VUL) policy, a type that builds cash value as well as tax-free gains for the policy beneficiaries. He has put $50,000 into the VUL and plans to make yearly $20,000 contributions. All smart moves, says Nash.

Zugheri also has an IRA worth about $90,000. He no longer contributes to it, and while the 401(k) and VUL are invested in low-risk mutual funds, he uses his IRA to speculate in stocks he picks himself. Nash calls that a risky strategy and says he's surprised to see it, given that Zugheri was "bit in a big way before." Nash suggests that Zugheri move the money in his IRA into more stable long-term investments. If he has a yearning to play the market, Nash advises opening a separate brokerage account and funding it with $1,000 a month. That way he's not gambling his retirement, and his losses, if any, will be deductible against capital gains.

Zugheri has about $18,000 saved for Mia's education. Some $12,000 is in a 529 plan, a tax-advantaged savings account for college costs, and $6,000 is in an educational IRA (now renamed the Coverdell), a tax-free savings vehicle that can be used for elementary- and secondary-school expenses in addition to college costs. That's important for Zugheri, who pays $1,000 a month for Mia's kindergarten. "It's out of control," he says. "I'm more afraid of private high school than I am public college." Because there are limits on the investment one can put into the Coverdell ($2,000 a year, after tax) and earning above a certain income makes a family ineligible to contribute, Nash suggests opening a supplemental account to help fund lower school. "You do not want to be incredibly aggressive here," warns Nash, "because you will need this money soon."

Nash praises Zugheri for his foresight on many planning issues, including his decision to have a Split Dollar Key Man insurance policy as part of the VUL, which will protect each business owner in the event of the other's premature death. Nash recommends adding a buy-sell agreement that will enable the healthy owner of the business to buy out the interest of a disabled or deceased co-owner. ("Disability covers income but doesn't address what to do [with the profits and the business] when someone is busting his ass and the other isn't," says Nash.)

After speaking with Nash, Zugheri feels positive about the plans he has in place and says he will follow some of Nash's suggestions for the future, including the buy-sell contract. "We do a lot of stupid stuff: We jump out of planes, we scubadive, we snowboard," says Zugheri. "Mark is right- we need something in writing to address the possibility of one of us becoming incapacitated." As far as Nash's plea to get him to stop day trading in his IRA, that's a harder pill for Zugheri to swallow. "I know it's a no-no, but it's like a doctor telling me to stop eating sweets," says Zugheri. "My appetite is not satisfied with a boring mutual fund or a boring bond. It's very tempting to go in and day-trade for the short term." Zugheri likes Nash's advice to open a separate account to day-trade, but says he'd need to take more money from the business to fund it, and that's a risk he's not willing to take. "The company is the goose that lays the golden egg. We need to keep the goose alive - without it, we don't have a 401(k), or private school, or anything."

SUCCESS

Expert Mark Nash of PricewaterhouseCoopers says Zugheri should:

Create a buy-sell agreement with his partner.

Stop gambling with IRA savings.

Divert some profit away from the business.

Last March two of the most exciting moments in John Gravely's life happened at once. His daughter, Taylor, was born, and - via his cellphone from the hospital - he worked on a $6 million deal to sell his software company.

It's a story most entrepreneurs dream about, but - like a new baby - the arrival of a new fortune brings with it monumental responsibilities and sleepless nights. Gravely, whose deal required that he stay on at c360 (c360.com), the Atlanta software company he co-founded in 2001, for a period after the sale, says his primary concern hasn't been buying a boat or picking out a plane but ensuring that the company stays in good shape. He's also focused on protecting his new wealth - 40% of which was issued in stock in CDC Corp. (cdccorporation.net), the publicly traded Chinese company that bought c360. As is often the case with these deals, the stock is issued in restricted shares, meaning among other things that Gravely can't sell it for at least one year. "My biggest risk is all that stock," he says. "I believe the company will be successful, but what if there's a downturn in the market?"

Gravely, 40, admits that there's a "settling-in period" as he tries to get used to life as a man of means. "I was never a rich guy," he says. "I never had family money." But he did have great bloodlines: His father was a serial entrepreneur who dabbled in car washes, gas stations, and real estate in Charleston, W.Va. By the time Gravely got to college, he had launched his own company, The Clemson Special, a weekly entertainment guide, which generated about $300 a week in advertising sales.

Upon graduation he worked various jobs, from construction to consulting, and invested all the money he saved into Home Depot stock, which rose enough to finance his next investment- an MBA in international business. After a series of jobs in professional services, Gravely struck out on his own in 2001 with Jeremie Desautels, a partner from a previous job, and a $14,000 investment.

When the two were ready to launch their first product, customer-relations management software (more simply put, tools for salespeople), cost concerns sent Gravely to Bangalore, India, to contract production. The software was a hit- before long it was delivered in eight languages and offered by more than 650 resellers worldwide. By 2005, c360 was doing $2 million in revenue, and by 2006 four companies were interested in buying it.

Selling it was a "no-brainer," Gravely says. "Like Seinfeld, I wanted to quit when we were on top." He also wanted the security. He and his wife each had some savings in IRAs and 401(k)s ("the average amount for people our age," he says), but they were concerned about saving enough and now, as parents of two, were worried about the cost of college tuition. And while the Gravelys owned their home, they needed a bigger house and couldn't afford to move.

Those worries are now in the past. Not only did the cash proceeds from the sale of the company help alleviate the budget squeeze, but the stock he received has skyrocketed since the purchase- to more than $8 a share from $4. Gravely will receive the money in eight installments over 24 months. Of course there are tax consequences: He will have to pay long-term capital gains taxes on the cash allotment, but he will be able to defer paying taxes on the stock until he sells his shares. Gravely put the cash earned from the sale, combined with previous savings, into three index mutual funds at Vanguard (one in domestic stocks, one in international stocks, and one in bonds), and he is looking into financial tools to protect his CDC Corp. stock.

Anthony Guinta, a principal at Homrich & Berg (homrich-berg.com), a fee-only wealth-management firm in Atlanta that works with high-net-worth individuals, says Gravely's No. 1 priority - to protect the value of his stock, since he can't sell it for some time - makes sense. Different hedging strategies do this, such as exchange funds (where the holder of a large block of stock exchanges those shares for interest in a diversified portfolio of securities) or synthetic investments such as an equity collar (which guarantees the stock won't fall below a certain price). After weighing the details, Guinta recommends a variable prepaid forward contract, another financial tool that puts a range around the value of the investment but that, unlike the collar, yields cash upfront. "In essence it's like taking a loan on the value of the stock," says Guinta. At the end of the term, Gravely can give the counterparty the stock and keep the cash (incurring a capital gain on the sale) or he can get the stock back and pay cash to settle up. The IRS recently began scrutinizing these contracts, but Guinta believes it's still a good fit for Gravely as long as he's familiar with the regulations.

As Gravely starts to see proceeds from the sale of the company, Guinta recommends strategies to minimize taxes and to achieve balanced growth. On the tax front, Gravely needs to plan around the alternative minimum tax (AMT) because he'll have a big state income tax bill on the gain from the sale of his business. Under the AMT Gravely will not be able to deduct his state income taxes. "He should consider shifting state tax payments [i.e., prepay when possible] to years when he pays no AMT," says Guinta. "That way, the state tax deduction can be used."

To achieve more stable growth, Guinta wants Gravely to consider making changes in his portfolio, now spread among three Vanguard index funds. "It's tax-efficient, low in fees, and a valid approach, especially when you are not sure what you'd like to do with the money," says Guinta. "But I'd like to see him add real estate, natural resources, and hedge funds." He acknowledges that some of those may sound risky, but adds that they should lower the overall volatility of Gravely's portfolio. Guinta recommends a "starting point" allocation of roughly one-third in U.S. stocks (right now he's recommending large-cap stocks), about 15% in international stocks, 20% in hedge funds, 15% in bonds, and the rest in cash, private equity, real estate, and commodities.

Guinta notes that Gravely must address other planning issues. The first is insurance. "Whenever you come into new wealth, you have to revisit your umbrella policy and bump it up equal to your net worth," says Guinta. "What if you get into a car accident? What if someone sues you? Everything can be lost if you're not properly insured."

The second major issue is estate planning. Guinta commends Gravely on already having a will and suggests that he should next set up irrevocable trusts for the benefit of his children. Specifically, he would assign a trustee to oversee any monies contributed now or in the future, and determine the ages at which the kids may access the money.

Gravely is in the process of selecting an attorney to help him set up the trusts. He's still evaluating strategies to protect his stock investment and, since speaking with Guinta, has dramatically increased coverage under his umbrella insurance policy. As for what's next, or the "go-to," as some financial planners and business brokers call life after selling a company, Gravely admits he's not sure. If he starts another business, he says it will probably be in an area related to one of his passions - perhaps music, travel, or the outdoors. For now, though, life hasn't changed that much. Gravely still goes to the office every day and still drives a 2002 Volkswagen Passat. "I'm the same guy," says Gravely. "I haven't done anything outrageous." After all, he adds, "I already bought the biggest purchase- peace of mind."

CASHING IN

Expert Anthony Guinta of Homrich & Berg says Gravely needs to:

Add to personal insurance.

Diversify portfolio beyond stocks and bonds.

Take steps to protect the value of his company stock.

Looking for help managing entrepreneurial wealth? Check out these websites.

The National Association of Personal Financial Advisors (napfa.org): NAPFA offers 1,550 "fee-only" financial advisors, including some experienced in helping business owners.

Financial Planning Association (fpanet.org): The site lists 4,500 certified financial planning professionals; you can search among the listed planners by geographical region or specialty.

American College of Trust and Estate Counsel (actec.org): Lists 2,700 attorneys who have concentrated on trust and estate law for at least a decade, and who have been nominated and vetted by other members.

Here's a taste of pricing arrangements for different financial services:

Fee-only planners charge clients for financial-plan development or investment management. Hourly fees range from $180 to $400 or can be based on investable assets (1% per year or so) or scope of the project.

Commission-only planners do not charge for consultations. They are paid commissions on the sale of financial products- a potential conflict of interest.

Wealth managers (planning plus investment management) charge about 1% on assets per year, and less once your assets pass $5 million (exotic investments, such as hedge funds, cost extra).