Ready to Retire? Ensuring a Business and It’s Owner Are Prepared for What’s Next
For many private companies, the most significant organizational shift will occur when an owner leaves the business or retires.
For many private companies, the most significant organizational shift will occur when an owner leaves the business or retires.
In the years leading up to a transition, owners must focus on preparing their business while still balancing their personal needs. But when is a company — and its owner — ready for a business succession? Consider these factors:
Exit planning should start as early as possible, even if an owner’s departure is decades away. Owners must regularly assess how much personal wealth will be needed to achieve their expected retirement lifestyle, quantifying savings targets and adjusting personal and professional goals as circumstances change.
Strategies that preserve wealth and create a tax-advantaged income stream following a departure will be important. It is particularly essential for smaller businesses, as proceeds from cutting ties can be less than expected after taxes and settling any lingering debts. Additionally, pay-out structures can vary, from lump sums to annual payments. That is why contributing to common retirement accounts — 401(k)s and IRAs — and leveraging plans like health savings accounts are as beneficial to owners as they are to employees.
Contingency plans for an unexpected transition, such as death or disability, are also essential. Funded buy-sell agreements, for example, protect remaining partner(s) and other interested parties amid such events. The deceased or incapacitated owner’s family may prefer to cash out their interests, so the agreement provides what is needed to buy out their share and maintain the viability of the business. Typically, a life or disability insurance policy assists the business in paying for the departing owner’s shares, pursuant to the agreement.
Transition planning often comes down to timing, especially when a business is sold to an external buyer. Along with historic company performance, current market conditions can drastically impact the proceeds an owner nets for a company. Unexpected events may affect business valuations and buyers’ motivations. For instance, owners who were ready to sell before the 2008 recession or COVID-19 pandemic may have had their plans upended by a wary M&A climate.
It is difficult or downright impossible to project future economic scenarios, but owners can still control many aspects that place their business in the best position to sell — such as a strong management team, diverse customer base and flexible structure to pivot with the fluctuations of the market. Those factors and more help a company maintain smooth operations and efficiency, making it more attractive to buyers, regardless of external factors.
Is the owner personally ready to leave? This question goes deeper than financial planning and speaks to someone’s goals for the next phase of their life. Business owners tend to be purpose-driven people — and quite often, their business and their purpose are intertwined, leading to seller’s remorse after leaving.
Owners should have a plan for how they will approach life without their company. Maybe it’s traveling, a dedication to charitable work or even starting a new business. Upon determining a new purpose, it’s time to return to the financial plan to ensure there will be funding to support it.
Readiness is among the most important components to successfully executing a business transition. A well-considered plan can still end poorly for an owner, the business or both if all stakeholders are not adequately prepared for what will be a major change.
Working with the right financial advisors can help owners know what to expect and confirm they and their business are ready for what comes next.
Visit fnb-online.com/FinancialPlanning for more information about the resources and expertise we provide.
**EMPLOYEES TO OWNERS**
A popular way to prepare a business for a transition — or simply to create a unique benefit — is to shift some of or even the entire ownership stake to employees. There are varied structures and methods to do this, but companies of all sizes are finding success with Employee Stock Ownership Plans (ESOPs).
Differing from stock options and other employee ownership initiatives, ESOPs are, essentially, qualified benefit plans, structured as trusts, that regularly award company shares to employees. Share allocations are normally based on tenure, compensation and factors determined by the specific plan. Upon leaving the company, employees receive a cash payout, which can be substantial depending on the business’ success and how the employee leaves (i.e., someone retiring after 20 years can receive more than someone who leaves voluntarily after five).
Establishing an ESOP can be complex and requires ongoing compliance, fiduciary and administrative requirements, but the incentives provided by a plan positively impact both employee retention and performance. For an owner and other shareholders, it aligns employee interests more directly with their own and strengthens succession planning by increasingly transitioning ownership to employees.
