Business Development Officer, T.D. McNeil Insurance Services, Fresno, California
A business owner uses a business to convert their human capital (skills, energy and time) into a stream of income. However converting that business into a stream of retirement income is a different issue. When a business owner wishes to retire they remove from the business one of its greatest assets—themselves!
There are a couple of options facing the business owner to use a business to generate retirement income. The first option is to sell the physical assets of the business for the best price possible and close the business. Under the best circumstances this approach will yield a percentage of the value of the assets and generates nothing from the good will of the business. However, this approach will free the business owner from all responsibility for the business and they can invest their time as they wish, free from the concerns of the business.
A second option is to sell the business as a “going concern.” Selling a business is complicated. Whoever buys the business expects that the business will pay for itself. People don’t buy a business on a whim. Unless the potential buyer of the business can secure outside financing (which is quite unusual) the business owner is actually going to become the banker for the people buying the business. The result is that a business owner will likely fail to realize the full value of the business.
In most small businesses it is the personality of the owner that makes the business successful. When that owner retires the greatest asset of the firm has left as well. Even your best employee cannot replace you. So now the business owner is the banker for a company that is probably going to be less successful and that will not generate much retirement income.
Many sole-proprietors have poured all their profits into the company. When they want to retire they find that they have invested in little else. Since it is expensive and complicated to establish a retirement plan for the employees the entrepreneur forgets to set aside money for his own retirement. If the business owner establishes a retirement plan, that plan might reduce the value of the business because of its long term obligations.
Often successor management fails. Making a success of a small business isn’t easy. If successor management fails owing the original business owner money, that business owner’s retirement income is jeopardized or worse yet, the former owner might have to come back into the business at a time when it is inconvenient and perhaps damaging to their health.
An entrepreneur can accumulate money for his own retirement by setting aside funds early in the business development. This is really difficult when the business is screaming for more cash. However, setting up a pension plan or other savings plan is crucial in order to have money on which to retire.
Grooming successor management can be expensive and difficult but it is the only way to prepare a stable person with the capacity to purchase the firm. There needs to be a direct transfer of the “face of the company” from the original owner to the successor. The bookkeeper may be great but he is unlikely to lead a company into success when high personal contact is required.
A business owner might consider selling the physical assets of the business, and also negotiate a contract that in exchange for a fee for a period of time at a stipulated rate the original owner will provide consulting for the successor. Then rather than paying a debt which is not deductible the successor is paying wages or a fee and that is deductible. The original business owner is receiving income rather than interest and payment of a debt.
A business may have limited value when it comes time to retire. Plan for your retirement now, while you can.
In Canada a "Sole Proprietor" often refers to a business owner who is not incorporated. If that is the case then there is no "going concern" business to sell only the assets of the business (Loss of good will.) If the business is incorporated, the shareholder can sell the company and benefit from the capital gains exemption. Whether or not a sole proprietor should incorporate is something that should be discussed with his or her professional advisors.
Business owners face additional challenges when planning for retirement because often the business is not only their source of revenue it is their greatest asset. A Retirement Planning Checklist and additional information on retirement and business succession planning can be found at www.jpw.ca.
If you have further questions, or feel that I could be of assistance, please do not hesitate to contact me.
President, Insurance Associates Agency Inc., West Chester, OH
The answer to the question is that you do it when you're ready. Now that my feeble effort at humor is out of the way, there are ways to leverage your company success into a retirement. You could work a mutual purchase agreement with a similar competitor. You could groom a key employee as a successor-buyer and help them finance the purchase or down payment. You can secure the sale with life insurance too.
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There are a couple of options facing the business owner to use a business to generate retirement income. The first option is to sell the physical assets of the business for the best price possible and close the business. Under the best circumstances this approach will yield a percentage of the value of the assets and generates nothing from the good will of the business. However, this approach will free the business owner from all responsibility for the business and they can invest their time as they wish, free from the concerns of the business.
A second option is to sell the business as a “going concern.” Selling a business is complicated. Whoever buys the business expects that the business will pay for itself. People don’t buy a business on a whim. Unless the potential buyer of the business can secure outside financing (which is quite unusual) the business owner is actually going to become the banker for the people buying the business. The result is that a business owner will likely fail to realize the full value of the business.
In most small businesses it is the personality of the owner that makes the business successful. When that owner retires the greatest asset of the firm has left as well. Even your best employee cannot replace you. So now the business owner is the banker for a company that is probably going to be less successful and that will not generate much retirement income.
Many sole-proprietors have poured all their profits into the company. When they want to retire they find that they have invested in little else. Since it is expensive and complicated to establish a retirement plan for the employees the entrepreneur forgets to set aside money for his own retirement. If the business owner establishes a retirement plan, that plan might reduce the value of the business because of its long term obligations.
Often successor management fails. Making a success of a small business isn’t easy. If successor management fails owing the original business owner money, that business owner’s retirement income is jeopardized or worse yet, the former owner might have to come back into the business at a time when it is inconvenient and perhaps damaging to their health.
An entrepreneur can accumulate money for his own retirement by setting aside funds early in the business development. This is really difficult when the business is screaming for more cash. However, setting up a pension plan or other savings plan is crucial in order to have money on which to retire.
Grooming successor management can be expensive and difficult but it is the only way to prepare a stable person with the capacity to purchase the firm. There needs to be a direct transfer of the “face of the company” from the original owner to the successor. The bookkeeper may be great but he is unlikely to lead a company into success when high personal contact is required.
A business owner might consider selling the physical assets of the business, and also negotiate a contract that in exchange for a fee for a period of time at a stipulated rate the original owner will provide consulting for the successor. Then rather than paying a debt which is not deductible the successor is paying wages or a fee and that is deductible. The original business owner is receiving income rather than interest and payment of a debt.
A business may have limited value when it comes time to retire. Plan for your retirement now, while you can.
Business owners face additional challenges when planning for retirement because often the business is not only their source of revenue it is their greatest asset. A Retirement Planning Checklist and additional information on retirement and business succession planning can be found at www.jpw.ca.
If you have further questions, or feel that I could be of assistance, please do not hesitate to contact me.