Here’s the reality of exiting a business: most small business owners will not receive a large enough payout to fully fund retirement. Point blank, your business isn’t a full nest egg eagerly waiting to send you off into a cushy retirement.
While upfront the initial sale amount may appear to leave you a nice cushion, after paying taxes, settling debt, and tackling closing costs, the final sale number quickly dwindles down to about half the initial value. We can’t forget the fact that the majority of business owners largely inflate the value of their business, which means the actual valuation comes in far below their perceived number.
For hardworking business owners, the final amount in the bank feels more like a sucker punch than a reward for decades of hard work.
Too many of the owners I work with are counting on the sale as their primary, if not only, funding mechanism for retirement. Unfortunately, most small businesses weren’t implementing proper long-term planning to successfully sell the business. This leaves retirement goals falling short.
By the time they start working with me, most are eager to exit. When we review exit goals and objectives, we quickly find that the amount “needed” to retire cannot be realized in an immediate sale.. The exit strategy then becomes focused on funding the retirement needs through the business.
Creative Strategy to Reach Desired Goals
One client Exit Consulting Group (ECG) worked with recently found his business falling very short of his desired retirement goals.
This business owner determined he needed 3 million after tax dollars set aside for retirement to enjoy his desired lifestyle. A stark contrast to his goals, the business evaluation came in at $1.5 million. After tax, that comes in at an estimated $1 million, a third of what the owner needed.
With the realization that the sale of the business couldn’t sustain retirement, our ECG team met with the business owner’s Certified Financial Planner to review assets and look for opportunities to increase the value or income potential.
The client owned the building that housed the business. This presented several different opportunities. First, we explored improvements over a five-year time frame to increase the value. We compared this to taking advantage of the current hot real estate market. Ultimately, we settled on selling the building then in a 1031 investment. While the business would need to pay rent to the new landlord, the business can afford the increase and deduct the expense. The new property purchased in the 1031 will bring in more after-tax cash.
That brought us closer to the desired retirement goals.
Next, we turned to the Defined Benefit Plan (DBP). After getting professional advisors to look at the option, we found that the profitable company can defer up to $300,000 for each owner into the DBP. This lowers the company’s profit and heavy tax burden.
Finally, we turned to owner distributions, evaluating what was coming out each year and where the money was going. We shifted the distributions from the immediate to the future.
By itself, the sale of the business fell very short of funding his retirement. Ultimately, however, through a complex series of calculated moves that included evaluating assets and restructuring different plans within the company we were able to get this business owner closer to his retirement goal.
Long-Term Planning Is Key
Successful retirement planning requires years of savings, diversification of cash, risk management, and proper planning. Selling the business needs to be just one component in an overall strategy.
Additionally, owners need a solid understanding of the company’s value in the marketplace. Their tendency to overinflate this number further weakens the overall retirement strategy.
I recommend that owners start evaluating their exit strategy three to five years prior to exiting. This gives us time to structure the business in a way to better reach retirement goals. Actions can include everything from implementing value drivers, restricting divisions, diversifying clientele, and more. In order to successfully sell, working towards funding a large portion of retirement, the business needs to be in its best financial and working shape ever.
If you are counting on your business funding your retirement, you need to start implementing a strategy to get there today. Contact our team at Exit Consulting Group to start outlining your goals and developing the roadmap to achieve them.