It is very common for business owners to think they can sell their business when they are ready to retire. In many cases business owners need this wealth to have security in their retirement. However, they may be miscalculating and be very shocked when the time comes to turn their business into cash.
Transition is inevitable in the life of a business owner. Someday they will exit their business for one reason or another. Death, disability, or retirement are the main reasons for an exit, however, there are other reasons why an exit may be needed (Death, disability, divorce, bankruptcy, voluntary leaving, retirement, and non-voluntary leaving).
The major questions to ask
- What if you don’t want to run a business any longer and you want out?
- What if you died, or became disabled?
- What if you lost your key person or your key group?
- What if you can increase cash flow?
A recent Business Owner Succession Planning Survey (FPA/CNBC) released in 2015, said 78% of small-business owners said they plan to sell their businesses to fund their retirement. Well over 70% of small business owners do not have any transition, or exit plans. Even if they have a plan, in most cases it is not concrete and for many reasons will not provide the results they think it will.
Many business owners have the intention to cash out at retirement. In the urgency to turn business assets into cash many small business owners take back notes to help fund the sale of their business. They are mortgaging their financial security and future based on the continuation of the business which they just sold. This is one of the many miscalculations in their retirement projections.
Wealth In Their Business
One of the biggest reasons why a small-business owner cannot exit their business is that because the majority of their wealth is tied up in their business. This can be most, if not all of their retirement wealth. They don’t have a plan to convert the business value to cash. Many owners also have very little, if any, personal wealth to supplement the shortfall because over the years most business owners put much of their wealth into the business with the idea of cashing out. This becomes a real shocker to the business owner when the day of reckoning arrives and they want to retire, or are forced to retire.
Many business owners are not aware of what it takes to sell their business and what they have to do to increase the value of the business. Strategies they can implement to make the business more valuable such as cash flow systems, key group members, delegation of major tasks, next level management personnel, a company culture, and many other strategies which need to be implemented over a period of time. The sooner they are implemented the better. These are value drivers that need a long time to create higher business value and improved cash flow.
Many business owners don’t have any idea how to value their business. Sometimes their ego gets in the way and the business owner sets a very unrealistic value. They set the value either too high as to eliminate many prospects, or too low, leaving 30-40% on the table. Many sales take a long time which may not be coordinated with the retirement date of the business owner and the need for income.
Waiting To Long
Because creating value to a business, requires long term strategies to be implemented, business owners limit their planning options because of the short period time they have to sell the business.
For example: Creating a solid management team may take a few years to get the right people trained and involved. Prospective buyers are buying your team and strategies, and not your talents. The truth is they don’t want you involved, but want your ideas and the talent you developed within the firm, namely, the middle management.
The Cost of Selling the Business
Owners miscalculate when selling their business as to the net amount they will realize after the sale. There will be income and capital gains, broker fees, M&A fees, commissions and miscellaneous fees for other advisors. It is possible that you can lose 30-50% of the sale price through fees and taxes.
The GAP is the number of additional assets you need when you retire to provide an income that will maintain your lifestyle. Once you figure how much additional income you need for retirement. You need to figure out what you need to net from the sale of your business. This is the GAP.
Example: Bob has $500,000 in his SEP plan. He figures he needs about $1,200,000 more to maintain the lifestyle he has been used to. He needs to calculate what he needs sell the business for in order to net $1,200,000.
Keep in mind, business owners are used to having many things paid for through the business; such as your car, insurance, cell phone, entertainment, dining, and other things. When business owners figure what they take in income from the business and what it takes to duplicate that income based on earning on capital, they realize they need more capital than first expected, especially in a low interest environment.
Some things to ask yourself:
- Do you have a catastrophic plan in place?
- Are you building wealth outside the business?
In conjunction with building your business and creating value by using the value drivers needed, the business owner should consider building wealth outside of the business.
There are many ways of doing this from setting up a retirement plan such as a SIMPLE IRA plan in In your business, or some type of retirement plan. A 401k can also be implemented in the business allowing for large deductions and contributions.
Life insurance is an excellent vehicle to use to wealth creation. Not only can you use this for catastrophic planning, but also for tax free income.
In extremely cash flow rich business, using a defined benefit program could be a great advantage to the older business owner. In essence using the business cash flow to fund the retirement within the defined benefit program.
Preparing your business to be sold at the highest value is like preparing to sell your home. Even though you don’t plan on selling in the near future, if you implement all the strategies which will help increase income and value, you will always be ready to sell at the highest amount when the time comes.