Following is a guest post from financial planner Josh Patrick of Stage 2 Planning Partners in Vermont. While the details of your circumstances may vary, Mr. Patrick’s message applies to all business owners: if you expect the sale of your business to fund all or part of your retirement, start planning now.
I’ve been speaking with and working with private business owners for over fifteen years. Most owners have a dream of running their business for their working career, finding a buyer and then riding off into the sunset with no other planning.
Thinking your business is all it takes to get to retirement is usually a myth. Let’s look at some of the statistics around private businesses:
- There are about 6,000,000 private businesses that employ people in the US.
- About 300,000 of these businesses do over $5,000,000 in sales.
- About 150,000 of these businesses do over $10,000,000 in sales.
- Private businesses on average sell for a multiple of between 3 and 6 times their earnings before interest, taxes, depreciation & amortization (EBITDA).
- The average private business has an EBITDA of between 7% and 13%.
If we take a business that does $10,000,000 in sales and has an EBITDA of 10% we’ll see the following in a sale situation:
|EBITDA of 10%||$1,000,000|
|Sales price of 4.5 x EBITDA||$4,500,000|
|Taxes & expenses on sale (35%)||$1,575,000|
|Net proceeds from sale||$2,925,000|
|Annual income available at 4%1||$117,000|
$117,000 or less is the conundrum that many private business owners face when they think about selling their business. In this particular case the owner has been enjoying $1,000,000 of cash flow before interest, loan principal payments, capital investments and taxes. This will in most cases be significantly more than the $117,000 the owner can get from selling their business.
And, this is a business that is doing $10,000,000 in annual sales, which makes it one of the top 2.5% of the businesses in the country. What would happen with you and your business? Are you in the top 2.5%?
If not, you might want to consider some of the following strategies so that you can afford to leave your business:
Start and fund a qualified retirement plan.
I call this pre-funding your buyout. While your business is creating significant cash flow, take $40,000 to $60,000 of this cash flow and put it in a qualified retirement plan. If you are able to get a 6% return and you fund a plan for twenty years with $50,000 per year you’ll have a retirement plan nest egg of approximately $1,800,000 at the end of that time.
Qualified plans are complicated beasts. There is a great deal of customized design that can go into your plan. You will want to use an advisor who not only understands your investments, but more importantly is an expert at what type of plan and how the plan can be designed.
In many cases you can tell your advisor how much money you want to save and they can put together a plan that fits those parameters. I’ve seen business owners who got a late start save as much as $200,000 per year in their plan.
Think about owning the real estate you operate your business in.
If it’s possible for you to purchase the real estate you operate your business in you should strongly consider this option. Many business owners who own their own real estate will sell their business but keep the real estate and collect the rent.
Like a qualified retirement plan, starting early with owning your real estate is important. Many owners will buy the real estate their business is in and then pay rent to themselves for fifteen years to pay off the mortgage. After the mortgage is paid off the rent starts flowing to the business owner. Sometimes the income from rent is more than the income from the principal on the sale of the business. Owning your own real estate makes leaving your business easier.
Before thinking about leaving your business do a financial plan.
A sad experience is when a business owner sells their business, thinks they are going to retire and then finds four or five years later they have to go to work for someone else. These sellers often have seller’s remorse. They wish they didn’t sell their business after all.
Doing a little financial planning before starting with a transfer strategy is always a good idea. The plan will tell you what your financial needs are before you start to plan the sale of your business.
Josh Patrick is a founding principal with Stage 2 Planning Partners, a wealth management firm located in South Burlington, VT and Albany, NY. Josh specializes in helping business owners make their lives better by helping them create value in their business and life. You can read Josh’s daily blog at www.stage2planning.com/blog.
 Many investment advisors believe that an investor can spend 4% of their principal every year when their investments are in a balanced investment account. This is not a guarantee of return. You should speak with your own financial advisor before making any investment or income assumptions.
Author: Barbara Taylor
Barbara is co-founder of Allan Taylor & Co. and a former New York Times blogger. She has been a small-business owner since 2003. Barbara lives with her husband, Chris, and their two sons in Northwest Arkansas.