If you are a business owner and are considering departing from your business to pursue retirement, you have probably started to consider your exit strategy. Planning for a successful departure is something I see more often than the traditional sale to a third party. Resources pertaining to selling to a third party often emphasize the needs of the business, and seeing it succeed after you are gone. Exit planning has a strong emphasis on focusing on the needs of the owner to be financially independent and comfortable after retirement. This type of strategic planning only works if the business is already established. If that is the case, it is never too early to start planning.
“The Three T’s” of Exit Planning
Exit Planning has become more of a trend in recent years, due to the number of Baby Boomers seeking retirement. Since 1965, we’ve had a flat population growth, creating the need for Boomers to find creative, practical strategies to leave their business. I am a fan of Steven Covey, and often reference his second named habit in his work, Seven Habits of Highly Effective People. “Begin with the End in Mind.” While planning your departure from your business, your first focus should be how to get peace of mind after you are finished. Consider the “Three T’s” before you begin planning your exit strategy:
- When do I get out?
- How do I get out of the departure, and how much money do I receive?
- What do I really get at the end of the day?
We’ve seen a lot of businesses close during the pandemic. Many of these business owners did not receive the level of compensation they deserved because they did not have a strategy.
Know Your Exit Strategies – To Sell or Not to Sell?
There are four possible exit strategies when considering exiting your business:
- Sell to a Family Member
- Sell to Key Employees
- Sell to an Outside Third Party
- Liquidate (The majority of business successions are liquidations. However, if you plan ahead, you can get much more out of your business than a one-time payment.)
The following strategies focus specifically on what to do when you sell to a family member or key employees. I will do another blog on the subject of selling to third parties.
How to Develop a Plan that Satisfies Everybody and “The Three T’s”
Nobody lives forever, so when you die, or become disabled, your business and employees will have to go on without you. Ideally, you plan your exit when you have financial freedom. However, the value of your business is not the question. The question is, “What is the value of your business to you, your employees, or your family?”
How much value do you need to get out of your business and exit with financial freedom?
Selling Your Business – The Best Way to Make a Profit
You have decided to sell your business! Ideally, the person you are selling to could just borrow the money, pay you, and you could be on your way to your first retirement adventure. Unfortunately, people are usually unable to just borrow such large sums of money. But there are other ways to keep you financially secure.
For reference, I will use this example throughout the course of this blog: Say you are looking to retire and you have decided upon an amount that will provide you comfort in your retirement. You have decided upon the investment income at $100,000, and you know that you will need an additional $100,000 per year to live the life to which you have become accustomed. Where does this money come from?
- Retirement Plan. You need to do it right, and you need to do it in a manner in which your business can afford
- Real Estate. Rental income can help you achieve financial independence. Leaseback options are a good opportunity when you are exiting.
- You can never start too early. Your financial advisor can help you stay informed about stocks and bonds.
- Selling Your Business. When considering selling your business, you need to consider not necessarily what the business is worth but what the business can afford. Go back to timing, terms, and taxes.
What are the Risks to Consider During Your Exit Plan?
There are always risks to consider when making a big decision about your business. Thankfully, there are many ways to mitigate the risks that coincide with business succession planning. When considering selling to a family member or key employee, it is advisable to make preparations in the event of an emergency such as:
- You or the family member or key employee passes away after the sale.
- Over 50% of men before the age of 55 become disabled. This does not necessarily refer to a permanent disability, but injuries such as broken limbs can seriously impair the progress of a sale or success of a business.
Mitigating Risks with a One-Way Buy-Sell Plan or Agreement
A One-Way Buy-Sell Plan is an arrangement in which a family member or key employee makes a formal agreement to buy your business upon a specific event, such as something happening to you, like death or disability. To lessen the risk of exiting your business, ask your attorney about the benefits of a One-Way Buy-Sell Plan. Depending on your goals as a business owner, this plan can be structured and customized to maintain long-term control and maximize tax efficiency! It is fairly flexible and financially attractive.
Most importantly, starting succession planning preparations will enable you to find out if your family member really wants to be an owner of your business. There is a big difference in the mentality and motivation of an owner and employee. Both are incredibly important roles, and both require specific strengths. However, if a family member or employee is not motivated to become an owner, you will find out once the One-Way Buy-Sell preparations begin.
Bonus Customizability. A One-Way Buy-Sell plan can also take into account the range of dates you have prepared for your retirement!
What if Something Happens to the Non-Owner Buying Your Business?
You need to put a life insurance policy on the individual buying your business, payable to you. The Law Office of Edward J. McCloskey will draft your document, but it requires a team of people to make this operation run smoothly. You will need a financial consultant, who is familiar with the state of your finances, as well as a tax professional. Business succession is a team effort, but the most important step is getting the ball rolling.
How to Plan an Exit Strategy When You Are Not Financially Independent
Being financially independent is ideal, but is not necessary to plan your exit strategy. You still need to get something out of your business! The following are two ways you can still profit off of your business and retire, even if you have not quite reached financial independence.
- Employment Contract. Let’s revisit our original example of the $100,000 per year goal. An employee contract can help you obtain the finances you need to maintain your lifestyle, while still participating with your business. As a technical employee, your company will be able to take your “salary” as a deduction, and you can still participate in fringe benefits. The negative aspect is that you have to pay income taxes on earned income.
- Consulting Contract. My preferred option is to set up a separate consulting company. I have never, in all my 50 years of practicing law, seen the IRS audit any of this. You can set up a small LLC consulting company in what essentially amounts to a matter of minutes. This way, your former business pays your consulting company the $100,000 per year.
The Ever-Changing Estate Gift Tax Exemption Equivalent
If you take anything away from this section, it should be the importance of monitoring the Estate Gift Tax Exemption. This exemption changes frequently, and keeping up can be difficult. To this date, the exemption is 11.7 million dollars per person, or 23.4 million for a married couple. But that number is already in the process of being modified and could change at any moment.
Keeping an eye on this number is useful for those interested in “gifting” business ownership to a family member. Why is this a consideration for some business owners?
Say you’ve got a business worth one million dollars. If you sell it, you have to come up with the million dollars out of pocket. If you only need $100,00 per year for 10 years, you can gift ownership to family members and enter into a consultant agreement for 1 million dollars. The agreement is that the family member owns the company without any undue taxes paid.
Contact the Law Office of Edward J. McCloskey for a Consultation!
Any business owner considering retirement already has a lot on their mind. Ease that burden by working with an attorney who has over 50 years of experience in business succession. Contact Edward J. McCloskey for a consultation today!