Can Your Business Be Your Retirement Plan?
May you lead an interesting life.
-Ancient Chinese curse
The world is continuing to become more volatile and dynamic. Obsolescence of products, people and processes occurs now at a much faster pace. Because of that, basing your need or desire to retire completely on your business can be one of the biggest mistake you will ever make. Looking to your business to be your retirement plan causes four primary problems:
Problem #1 – All your eggs are in one basket: over time, we have watched a number of businesses succumb to situations where a sale of the business is not possible to be able to fund retirement.
Economically, right now we are in a down cycle. Most businesses, if they were to be sold right now, would get pennies on the dollar. At other times, you may get very handsomely paid for selling your business…but it is very difficult to control when you sell. If you are not in an up cycle, you may have a rough time getting the price you need (after tax) to survive and enjoy a good retirement.
1- From an industry perspective, you may build a great business, but if your industry gets hit with an increase in the costs of inputs (i.e. copper or corn) or is hit with regulations (i.e. ground tanks for convenience stores), what was a profitable, desirable, and sellable business can become a liability.
2-At times, we have seen individual businesses hit with losing a few key people, or a lawsuit, or other event which makes the business tough to sell at a good price. Most of these type of events open a big door to the unknown that will prevent most buyers from even being willing to make an offer.
Bottom line, having all your eggs in one basket is not a safe way to live your life and risk your lifestyle when age, medical issues and time may prevent you from being able to rebuild.
Problem #2 – Businesses are illiquid: Reinvesting everything into the business subjects it all to the illiquidity and risk of an operating business. While stocks and bonds have lately been volatile, they are at least liquid. Getting liquidity from an operating business can be challenging. While income, perks and dividends from a business can be substantial, business needs and taxes greatly reduce the ability to get large chunks of cash out of a business. Usually wealth comes out of a business slowly over time. As our clients get older, they desire to have more liquidity and flexibility and it is unwise to rely on the business as the answer for doing it quickly.
Bottom line, liquidity is an important element to having a solid net worth. While your operating business will always ultimately produce a better rate of return and more wealth for you, there is value in liquidity for prevention of problems, fixing problems and having a more consistent quality of life.
Problem #3 – You have to make the deal of your life. When I have been involved in negotiations where the owner “must” get a high price for the business because he has very little other wealth, those negotiations are very painful, take a long time and seldom does the owner seem happy at the end of the transaction. Where clients have built up a solid net worth outside the business with a reasonable amount of liquidity, the negotiation is not a “have to do it” or “make or break deal”, but usually gravy that puts the final piece into place of a long term “building net worth plan”.
It may be exciting in the movies to have all of your money riding on one big bet…but in real life, it is not fun and typically leads to some very poor decisions that affect lifestyle and strain the relationships of the family, particularly if the result is not what you needed it to be.
Problem #4 – Taxes and perks can be difficult to pay and replace when you sell your business. Between capital gains (which will probably be much higher in the future) and recapture of depreciation at ordinary income rates, the after tax value of selling a business is much less than it seems at first blush. Additionally, when you add the need to pay for health insurance, have a vehicle, traveling, etc., your “salary” as an owner may only be part of what you need to replace if you sell the business since you also need to be able to replace the “perks” (unless you and your family are willing to lower your lifestyle).
In a recent example, a client had a salary of $150,000 plus $50,000 bonus. Perks added another $80,000 to his lifestyle. To replace the $280,000 lifestyle that which he and his wife, children and grandchildren enjoyed, he would need $5,600,000 of invested assets to be able to replace the $280,000 of lifestyle he was getting from the business (assuming 5% earnings). To get the $5,600,000, he would have to sell his business for over $7,000,000. The reality was that the market value of his business was under $3,000,000.
One Option – The Net Worth Plan: One alternative is to build a Net Worth Plan. Rather than putting all of your eggs into an illiquid, high-risk basket, determine what your financial targets are for having:
For example, we have a young client who continues to build cash by sidelining 10% of his revenues from the business. He maximizes his contribution to a retirement plan with a safe harbor 401k. Each year he adds one residential real estate rental to his portfolio. The business has a strategic plan that is focused on controlled growth. His net worth over the next 5 years will still be focused mainly in the operating business, but the liquidity that he will have from Cash and Liquid Invested Net Worth along with the cash flow from the Real Estate will have him less and less dependent on the business over time.
Also as important, this owner will continue to watch his personal budget so he grows his personal spending by less than the growth of his business income. If he grows the bottom line of his business by 18% this year, he will only add 1/3 of that (6%) to his lifestyle next year. He will keep his personal spending a few steps behind his growth.
With this client, we do The Board of Advisors Meeting annually, where his wife, CPA, attorney, investment, insurance and other close advisors will look at his net worth and give feedback on what they believe needs to happen for him to solidify his overall situation and become less dependent on the business. We also look for opportunities to make the business less dependent on him by adjusting legal documents, corporate structure or 401k plan design as laws change.
In summary, it is risky and dangerous to rely on your business as your retirement plan. Using your key advisors and building and tracking a Net Worth Plan will not only make retirement what you want it to be for you and your loved ones; the journey along the way will be much better.
The Comprehensive Independence Builder
If you are interested in learning more about a balance of wealth through a Net Worth Plan and how it can help you avoid a limited quality of life where you may be unable to retire, please contact us.
You may also wish to learn more about our unique process for Business Owners called The Comprehensive Independence BuilderTM, in which we address all of the obstacles you face and help you use innovative strategies to protect and enhance your business, improve your quality of life and better achieve your goals.
To schedule your Independence Exploration Session or for more information, please contact us at 800-786-4332 ext. 108, or firstname.lastname@example.org.