By Tim Mezhlumov, CFP®, CLU®, CFS, EA, Director, Advanced Markets, 1st Global
Much has been written about the demographic trends and macroeconomic factors that continue to affect succession planning for small business owners. Most of it can be boiled down to three key points. First, a great number of business owners approaching retirement are looking for an exit plan. Second, the global financial crisis has negatively affected cash flow and diminished the profits of many small businesses. Third, a lack of credit availability has limited the pool of potential buyers.
Those three universal factors affect nearly every small business, but two additional factors can exacerbate the succession process even more:
1. The business owner lacks sufficient liquid assets to provide the desired retirement income.
Many small business owners reinvest most, if not all, of their profits back into the business in order to grow. This important practice in propelling the business forward often comes at the expense of making sufficient contributions to retirement plans, such as 401(k)s and IRAs, in order to support a comfortable lifestyle in retirement. The result is that these small business owners often have relatively little liquid retirement savings compared to the value of their business and overall net worth.
And what about the business itself? In many cases it is illiquid because it is difficult to sell to a third party due to a number of factors including geographic limitations or the absence of an interested buyer. So what often happens is that the business owner continues owning the business and working well into his or her golden years.
2. One of the business owner's children works in the business but the others do not.
This challenge can be addressed with life insurance, but it can be a long time before policy proceeds are available to the children. Disharmony and resentment can arise among siblings if one child assumes control of the business and dictates whether any cash payments or dividends are paid to the family. If cash distributions are not made, the siblings who are not in the business are not able to enjoy the benefits of partial ownership in the business. This typically leads to strained relationships not only the among siblings but their spouses as well. It can also affect the relationships among grandchildren depending on their ages.
Therefore, business succession planning must answer three questions:
- What will happen to the business?
- What's the best way to provide retirement income to the business owner?
- How can the business owner be fair and equitable to the next generation?
When you engage your financial advisor to assist with business succession planning, the following solutions should be considered:
- Buy/sell agreements for death and disability scenarios including one-way buy/sell for intergenerational planning
- Business and individually owned life insurance
- Qualified retirement plans such as 401(k)s
- Non-qualified deferred compensation plans
- Key person insurance
- Corporate sponsored long-term care insurance for the parents and the children who work in the business, as well as their spouses
- Disability insurance including personal income replacement and business overhead policies
- Section 1031 tax-free real estate exchanges
- Various trusts such as charitable remainder trusts or grantor retained annuity trusts
- Company recapitalization strategies
- Discounting techniques
Business owners should start the planning process for the sale of their business early. Typically, a five-year time frame is sufficient, but some business dispositions may take longer. Inaction is likely to lead to a lower sale price and less available cash flow during retirement. If you are a small business owner, married to one or the child of one, consider having this conversation with your financial advisor.
1st Global was founded by CPAs on the belief that accounting, tax and estate planning firms are uniquely qualified to provide comprehensive wealth management services to their clients. Each affiliated firm is provided with education, technology, business-building framework and client solutions that make these firms leaders in their professions through dedicated professional client relationships built around wealth management.
1st Global Capital Corp. is a member of FINRA and SIPC and is headquartered at 8150 N. Central Expressway, Suite 500 in Dallas, Texas 75206; (214) 265-1201. Additional information about 1st Global is available via the Internet at www.1stGlobal.com.