by Rob Vogel
When Your Retirement Plan is Based on Selling Your Business
As an entrepreneur and small business owner, you may be justly proud of the success you’ve had developing your enterprise. At Lucas Capital Management, we work with a lot of business owners. While most have devoted a tremendous amount of energy creating a valuable asset, many spent little time planning how they will manage the risk of funding their retirement through the sale of their business.
It’s not uncommon for business owners to tie up their entire financial future in their businesses. By planning early and diversifying investments, you can improve the likelihood of a secure retirement.
It’s crucial to develop a selling plan well in advance of your retirement. The plan should address the issues that can reduce the selling price of the business. Also, the plan should evaluate how to think about your personal assets before and after you sell the business. After all, if your entire future is based on any one specific event, you have introduced significant risk into your life.
Some risks to consider:
- Even though your current income is strong and the future looks promising, markets change over time. Your business may lose value between now and retirement. Things move quickly in today’s commercial markets. Naturally, business owners like to believe that they’ve built businesses of enduring value. Sometimes that’s true, but it is not wise to risk your entire retirement on that belief.
- Your company might have more value to you than to another buyer. Do you know what an independent third-party buyer would pay for your business? Another problem might be that your financials are not telling the best story they could. Many buyers will insist on having GAAP compliant and audited financial statements that will support your asking price.
- Do you have the staff to keep the company operating at top capacity when you are gone? If you’re like many small business owners, you fill more than one role to keep the company running. Buyers may want assurances that they are inheriting a functioning enterprise with experienced and skilled managers. Otherwise, buyers are simply purchasing assets, and that may result in a much lower price.
- Are your personal relationships the reason for success? A buyer will want to know about your relationships with customers, vendors, suppliers and investors. Can you demonstrate long commercial relationships that are likely to continue once you retire? Are your sales overly concentrated among just a few customers?
Planning now will help you reduce the impact of those risks by diversifying your assets beyond just your business.
Find the best retirement strategies for business owners. Contact Lucas Capital Management to see how we can help.
Start Planning 5 to 10 Years Before Selling
Business owners may actually need two plans, and they both benefit by an early start.
The first plan addresses how you will prepare your company to provide the maximum after-tax benefit when you sell it. You will need much expertise to get this right, including accountants, tax specialists, merger and acquisition consultants, and lawyers who specialize in the sale of businesses. Also, you will need to recruit good managers who can start relieving you of some of your duties so that your business is not “owner dependent.”
But it’s the second plan that many owners neglect – the plan for diversifying your personal assets well before you sell the company. This plan also requires years of preparation in which you consider your long-term wealth. Items to address include:
- Balancing the funds reinvested in the business with your annual salary/draw from the business so that you can redeploy your money in non-related assets.
- Utilizing tax-advantaged retirement plans to accumulate and diversify assets without the friction of current taxes.
- Engaging with a financial advisor who acts as a fiduciary to help you balance building your personal wealth in addition to the value of the business.
- Creating an estate plan, including a will, trust accounts and the naming of beneficiaries.
Working with a financial advisor who specializes in retirement planning for business owners can be the key to success.
When You Are a Year or Two From Selling
With just a year or two left, you’re ready for your plans to kick into high gear. You will need to reach some critical decisions at this time, and to take some important actions to make the sale as remunerative as possible. This includes:
- Considering tax implications when structuring the terms of the sale. Your after-tax return is what’s important.
- Taking advantage of the Qualified Small Business Stock exception to exclude some or all of your capital gains from taxation.
- Considering converting a C Corp to an S Corp and save on the Medicare surtax of 3.8 percent.
- Fully understanding the risks of seller financing. For example, you will be tied to the business for a long time after the sale. During that time, you risk the buyer defaulting on the financing. Seek professional guidance to minimize the risks of seller financing, or avoid it altogether.
- Considering the healthcare implications for you and your family. You may want to require the company to continue paying for your healthcare even after the sale is complete. You would have to negotiate this as part of the sale agreement.
- Donating a portion of your business to a Donor-Advised Fund (DAF) before sale. You are allowed to take a tax deduction based on your company’s value and avoid paying capital gains tax on the sale. This tax-efficient strategy is used by many business sellers to set aside a pool of charitable dollars for the rest of their lives.
As you can see, retirement planning for business owners can be complex, and your future depends on the decisions you make now. Don’t put off planning until the last minute – get started early and utilize professionals to help get the maximum value from the sale of your business. Contact Lucas Capital Management to see how we can help.