Succession Planning | What does the small business owner do when retirement is looming?
There's a fatal flaw in the retirement strategies of many small-business owners: After they pour a lifetime of sweat, time and capital into building the business, their rough-sketch strategy is to sell out someday for a ton of money, then settle back and enjoy a financially secure retirement. Many business owners are so sure this will happen that they don't bother to make any other retirement plans.
Who is this person who, at just the right moment, is going to show up with cash in hand to buy the company — and pay a fair price? For thousands of small business owners each year, no one steps forward. Perhaps the business is too specialized or tied too closely to the owner’s unique personality and skills. Or perhaps possible buyers equate “retirement sale” with distress sale and make only low-ball offers. Whatever the reason, many owners find their company has suddenly become a white elephant nobody wants.
One way to guard against this is to groom your own replacement, someone who will buy your company when you’re ready to retire. Maybe this person is a current co-owner (but be careful if he or she is around your age and counting on retiring around the same time.) Or it could be a son or daughter active in the business, or a younger key employee.
Business owners who successfully groom their own replacements leave nothing to chance.
They realize there’s no room for error at the point of retirement. Here are some practices of savvy owners:
• They’re cautious. They make sure the heir apparent is the right person in temperament, personality, competence and personal goals.
• They establish a probation period so they can terminate the relationship if they find this person simply won’t work out. During that period, they keep everything informal — strictly verbal. At the same time, even when they go to a formal agreement, they make sure it contains a termination provision.
• They fashion “golden handcuffs” and incentives to ensure their replacements stay until the baton is passed. An ambitious successor needs and deserves gradually increasing authority and benefits. Options include deferred compensation or the opportunity to acquire partial ownership before they retire. This provides both parties with something to win by sticking to the agreement — and something to lose if it falls apart.
• They put it in writing. With the help of an attorney, they lock in who does and gets what, spelling out all details and caveats, including how to establish the final valuation of the business. This formal buy/sell agreement protects everybody.
• They build in a funding mechanism. This is crucial. No matter how good the terms of the buy/sell agreement, it will be worthless if the money is not there when it’s needed to carry out the plan. Under one option, the successor may be able to purchase the company from ongoing profits. Other options include setting up a sinking fund or allowing the successor to simply borrow the money. These options may work, but they leave much to chance. Instead, consider an insurance vehicle that protects your family if you become disabled or die prematurely.
• They have a backup plan. As a business owner, you know very few things go exactly as planned. What if your business hits tough times or your successor dies, becomes disabled, or—all too common—leaves because of a personality conflict? Or what if there simply is no heir apparent? Sometimes, it’s simply best to dismantle the business.
Whether or not you have a possible successor for your company, begin mapping out your retirement strategy today. Your insurance professional or your independent professional advisors can help you develop it.
Dennis Seeley is a financial services professional with New York Life Insurance Co. in Westborough. Contact him at dseeley@ft.newyorklife.com.
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