By Thomas Fowler
Transition is an inevitable experience in the life of a business. Business owners can deny it, run from it, fight it or try to avoid it. They can wait until transition is forced upon them by age, infirmity, disability, circumstances or change of direction. Or they can acknowledge it, plan for it and manage it.
One thing that’s certain is that one day every business owner will exit their business because of death, disability or retirement. Studies conducted by numerous professional organizations inform us that the majority of business owners have not taken the necessary steps to plan their ultimate transition out of the business.
According to the FPA/CNBC Business Owner Succession Planning Survey released in 2015, 78 percent of small-business owners said they plan to sell their businesses to fund their retirement. Unfortunately, these owners often miscalculate what their true retirement income needs are. When they sell the business, they often have to finance the purchase with a series of notes. They overlook the fact that they are mortgaging their financial future on the continued success of the business.
In my experience, one of the biggest reasons a small-business owner cannot exit their business is that the majority of their wealth — 60 to 80 percent — is tied up inside the company. They have no plan to convert the business value to cash and very little if any personal wealth to supplement the shortfall. This is “The Great Awakening.”
Business owners often find they own a well-paying job instead of owning a business that has value to a potential buyer. There is a huge perception gap on the part of business owners on what it takes to capitalize on a successful sale at the end of their career.
Most have no concept of how to value their business. Either their ego rules the day and sets an unrealistic business value, or they sell but end up leaving 30 percent of value on the table. When business owners wait too long to begin planning, they can find themselves with a limited number of planning options because of that short time frame. How do we, as advisors, motivate then to start the planning process? We start where we can.
Ask the Right Questions
I believe there are a number of questions that a business owner must answer to exit their business successfully. The first is “Do you have a catastrophic plan in place?” The second is, “Are you building wealth outside the business?”
Creating and implementing a wealth- building strategy outside the business may be the first step in creating the ultimate business transition plan. If a business owner has created personal wealth apart from the business, they have maximum flexibility in their transition planning. If they haven’t built wealth outside of the business, they are more dependent on circumstances and the decisions of others.
There are many ways to create wealth outside the business. One of the easiest is to have the owner implement one of the tax shelters the IRS provides, such as a qualified retirement plan. You can start with a IRA or a SIMPLE 401(k) plan. These plans are easy to implement, have virtually no expense costs and can be created with a small dollar outlay.
As the company grows, the owner can implement a 401(k) plan, which allows deductions from $18,000 up to $53,000 per owner, depending on how the plan is structured and the person’s income. If the business owner hasn’t accumulated what they need in their 401(k) plan, they could consider adding a cash balance plan, which allows contributions up to $250,000 or more depending on the owner’s income and age.
Life insurance is an excellent vehicle for building wealth outside the business. It can be part of the business owner’s catastrophic plan. If the owner dies too soon, life insurance provides for the family. It provides a tax-free income in retirement. It can provide a death benefit as well. Life insurance is self-completing. Should the owner become disabled prior to retirement, waiver of premium can be included to guarantee the contract benefits with no additional premiums paid. Plus, in many states, life insurance proceeds are exempt from creditors’ claims.
Assisting business owners in building wealth outside the business may be the best way advisors can help the owners mitigate the potentially disastrous results of The Great Awakening. It is an essential step in creating the ultimate business transition.