One of the activities small business owners delay most frequently is planning for their exit from the business. They feel that it’s too soon to plan an exit when they first start a business, then find additional reasons why the plan should be put off along the way. Planning ahead in this case is not just a formality, however. The exit plan will actually play a role – and at times a very significant role – in the development of your business.
Your exit plan will impact the type of retirement you can have. The wrong strategy can result in less retirement income than you were counting on. There are many aspects to consider when planning for the day before your retirement starts.
Here are five of the most common mistakes we see:
Not knowing the actual value of your business
Most business owners think their business is worth more than it is to an objective, third-party observer. Not having a clear picture of what the business is worth makes planning for a secure retirement almost impossible.
To avoid this, get an independent third-party valuation of the business at least 3-5 years before you plan to retire. This will enable you to calculate whether the value of the business plus your other assets will be enough to sustain your post-ownership standard of living. And knowing the value of the business years before a planned exit gives you time to implement strategies for increasing the value of the business, which will make it more marketable.
Not reviewing your legal documents
Most owners have legal documents that cover the disposition of the business in the event of their death, but not if there is a disability, divorce, personal bankruptcy, termination, or retirement. These can be even more important in partnerships. We have seen it happen that one partner has passed on or gotten divorced, and the other partner is left to run a business with the late or former spouse as a part owner. Those cases are really (not) fun.
Business owners need to review their legal documents with their advisers every two-to-three years or when a life event occurs. Make sure you review Operating Agreements, Stock Purchase Agreements, and personal documents such as wills and trusts. These never seem that critical until they are.
Not planning for the taxes on the sale
Getting a single payment for millions of dollars might sound great until you have to pay the taxes on it. You need to plan for the tax consequences of your sale. Assembling a team of qualified professionals who know the business and industry, the owner’s goals, and the tax consequences of each ownership transition option can help the owner keep more of the value they have created over their lifetime. The net value you receive once all taxes and fees have been paid is what matters to your retirement planning and your family’s net worth.
Not carefully considering every ownership transfer option
A key piece of every succession plan is how the sale of the business is structured. It is critical that you consider every option available to create a market for your ownership interest. Options to sell to family members or a strategic competitor are most usually considered. Other options include selling to employees through an Employee Stock Ownership Plan (ESOP) or Worker-Owned Cooperative (Co-op), which could allow you to defer paying capital gains tax on the sale and provide attractive tax mitigation options for the business post-sale. Knowing all your options allows you to consider the best way to bolster your retirement assets while leaving the business with the best possible ownership for long-term success.
Not diversifying your wealth
Many owners reinvest most of their profits to grow the business, and that reinvestment should earn a strong return if growth is properly managed. But a privately held business is an illiquid asset that can take many months (if not years) to sell. Therefore, prior to and throughout the succession planning process, you should diversify your net worth by using more liquid retirement planning options such as company 401(k)s and cash balance plans to maximize the amount they are shielding from taxes while they work on preparing their business for sale.
Do you have questions about your best strategy for an exit? We’d be delighted to talk to you so you can start working toward the retirement you want and deserve.