Plan early on how to get out of your business
When it comes to monitoring health, doctors often prescribe based on numbers associated with your blood pressure and cholesterol among other factors. As a business owner, knowing your financial and retirement target numbers is just as important — having the information can help you keep the company healthy and running well into the future.
If business owners do not know how much capital they need to live on for the rest of their lives and how much their business is worth, things can spiral out of control quickly.
At least 10 years before retirement, entrepreneurs should develop a strategy to extricate themselves from the enterprise and meet their personal and business related goals. This could mean selling outright, allowing a family member or child to buy you out, or setting up a period of time that allows a key employee to buy you out while you continue to receive a paycheck. The key is to begin planning not at the end but in the movable middle age for a business, when options are more plentiful and a Plan B can be viable during a business owner’s working life.
In my small business planning practice, many owners tell me they consider their future needs but in some ways it can be like daydreaming. Many business owners have their heads down, building their business and only look up when they are quite close to retirement — which is often times too late.
Many baby boomers fall into this situation because their outside investments took a turn for the worse in the market. They come in to see someone like me to determine what options are available to them. When you know your target number, you are in a much better position to respond to offers, and to determine the “if, when and how” of transferring or selling a business.
Typically I suggest a business owner is going to need about 70 percent of his or her income to be comfortable in retirement. So it is important to note that not all business owners are going to have an opportunity to sell, especially without careful planning. John M. Leonetti notes in his book “Exiting Your Business, Protecting Your Wealth: A Strategic Guide for Owners and Their Advisors” (John Wiley & Sons, Inc., 2008) that, “According to a U. S. Chamber of Commerce study only 20 percent of the businesses that are for sale will successfully transfer hands to another owner.”
To avoid overreliance on the sale of their business, entrepreneurs should save 20 to 25 percent of their gross income outside of the business and diversify assets such as retirement insurance and investments so their entire net worth isn’t tied to the company. Such a move gives owners flexibility in an exit strategy.
As an example, two brothers in their mid-60s who owned a service company worth about $4 million wanted to retire. One brother had a son in the business, the other did not. The younger brother did not want to remain in business with his nephew. Because no one buyer would give them $4 million in cash, we looked at other options. Ultimately, the older brother and son bought the other brother out and the son began to buy his dad out to own the business outright. But if we did not know each target number and what was important to each family member, the situation could have been ugly.
In another example, an owner of a small manufacturing company was made an offer that on its face looked fantastic. Yet as the numbers were run, the offer ultimately fell short of his target number he needed to live comfortable in retirement. He decided to keep working.
These stories illustrate why it’s critical for business owners to meet with their team of advisers. A miscalculation in what the business is worth or how much capital you need to live can lead to big mistakes later on. As I tell my clients, “never step over a dollar to pick up a dime.”
Michael Moran is a financial professional with MassMutual’s Commonwealth Financial Group in Boston.