Greg Welborn is a principal at First Financial Consulting with over 30 years of experience writing on financial planning topics.
If you’re a business owner, you’re comfortable with risk. While that’s a fantastic quality for building wealth, it can work against you when planning for the future. Too often, optimistic entrepreneurs put off serious planning until they are close to retirement. That’s why retirement planning for small business owners is such a challenge. For a truly confident future, you should have a clear roadmap in place years in advance.
Ask The Big Question
Do you have enough to retire on apart from your business? If you’re one of the lucky few who has parlayed your business success into many other assets, you might be in a position to afford your ideal lifestyle regardless of what happens to your business.
If that’s you, your retirement planning will be straightforward. However, if you’re like most, you will rely on your business for at least part of your retirement assets and income. And that’s where the real work starts.
Give Yourself Enough Runway
Retirement planning requires a different mindset for most entrepreneurs. During the accumulation phase of your financial life, plowing profits back into your business probably made sense. But when it comes to preparing for retirement, you now want to actively diversify away from your business.
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Why? For most business owners, selling their company is one of the most difficult things they’ll ever do. Research suggests that only 20% to 30% of businesses that attempt to sell actually do. Of those that did sell, how many ended up transacting at a steep discount simply because the owner’s retirement depended upon it?
What’s Your Plan B?
And it’s not only the sale that should concern you. Businesses that look rock-solid one day can change overnight. The pandemic crippled many successful companies with no advanced warning. What if a different disruptor enters your industry suddenly and your business loses substantial value? Do you want to take on that risk, or do you want to formulate a Plan B?
I advise all business owners to develop that Plan B: a purposeful build-up of retirement assets outside your business. This way, you can diversify and hedge your bets. Yes, if your business fails unexpectedly, it will hurt. Still, it won’t be a fatal blow to your lifestyle if you prepare sufficiently.
So, you’re ready to prepare. When should you start taking action?
15 Years Before Retirement
Start developing your Plan B if you haven’t already. Do you have even more time than 15 years? Start now and let time help you compound your resources.
Especially for small business owners, consider starting a defined contribution plan, such as a 401(k) plan or solo 401(k), to put away as much as you can on a tax-advantaged basis. Or at a minimum, contribute to a Simple IRA, SEP IRA or even a traditional IRA. If you’re 50 years old or older, don’t miss “catch up” contributions, which allow you to save more. Contact your tax advisor to discuss structuring employer contributions and to take advantage of available contribution limits. Also, it’s wise to seek investment advice to make sure you’re investing appropriately for your situation.
Next, start preparing your company for sale. Who do you plan to sell to? If you plan to sell to an outsider, your job is clear: maximize the attractiveness of your business so it will have the most value to a third party. You can take many steps to do that, from increasing profit margins to implementing systems to documenting all key roles.
If you have children who want to take over, it gets more complicated. You might have a tug of war between extracting value and saddling the kids with debt. You will need to find the right balance.
This is the time to invest in intergenerational planning. You can do this with a professional or on your own by starting to have regular family meetings. Tell the kids what you’re thinking. Actively solicit their thoughts. Keep in mind that what is fair isn’t always equal. If your daughter worked for 10 years and helped you double the business, it would not be fair to give her the same share as other kids who didn’t participate. Find creative solutions to create an equitable situation. And keep the conversations going; get tough topics on the table now while there’s plenty of time to find solutions. Financial advisors can help add structure and smooth the discussions.
Five Years Before Retirement
If you’re selling to an outsider, and there is about five years before you plan to retire, now is the time to start prospecting for a buyer. Especially for specialized businesses, be open to transitioning sooner rather than later. The “right” buyer won’t magically appear the day you want to exit. Be flexible.
If you’re selling to family or employees, you may want to plan an early transition while you can remain and act as a mentor. Waiting until an illness or death forces the transition can put the business at risk. Expecting customers and other stakeholders to accept a sudden change is risky. Time is your friend; use it to smooth the transition and manage your risks.
If you’re leaving the business to your kids, I have one more suggestion. Write a personal note to be delivered upon your death. Explain the “why” behind your wishes and encourage the children to work together constructively. I’ve seen too many families and businesses torn apart by tensions among siblings after the founder’s death. Including a personal document alongside your legal wishes can go a long way in smoothing out any confusion.
You’ll also need tax planning to make sure the tax person gets his or her cut but no more. There are ways to minimize tax liability as long as there’s enough runway left to find solutions.
Don’t wait; putting off retirement planning can potentially put both your business and your personal future at risk. Fortunately, once you start the planning process, you’ll feel much more confident about the road ahead.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.