The wealth of many boomers is tied up in businesses they own. And that can be a problem when it comes time to retire.
Too many owners aren't prepared for the day when they'll need to cash out. Some haven't done their homework to figure out what the business is really worth. Others undermine their company's value with their inability to let go.
Advance planning for the sale of a business is more important than ever, given today's economic uncertainty and how portfolios have suffered over the past decade. Even when families transfer ownership to the next generation without a sale, the tax consequences can be huge without proper planning.
Below, financial advisers and exit-planning specialists weigh in on some of the most common mistakes business owners make when they're ready to retire, and how those mistakes can be avoided:
The Mistake: Creating a Business That's Too Dependent on the Owner
One of Paul Pagnato's boomer clients spent decades building his company. When he decided to retire, he was not only chief executive, he was handling all key decisions in marketing, sales and client service, despite having hired executives to handle those functions.
"He was the business," says Mr. Pagnato, a Washington, D.C.-based adviser who works exclusively with entrepreneurs. But Mr. Pagnato says having a business too dependent on the owner or a handful of major customers can dramatically hinder the company's sale price, as buyers are likely to perceive more risk. Indeed, Mr. Pagnato's client ended up selling his business for less than he originally planned and was required to stay on longer to insure a smooth transition.
The Fix: Mr. Pagnato says it's important to delegate responsibility well before the sale to help insure a smoother transition and diversify the company's customer base.
The Mistake: Ignoring the Tax Benefits of Planning Ahead
Adam von Poblitz had a client whose 10-year-old business was valued at $20 million two years ago. The owner had always planned to transfer an interest to her son, says the New York City-based estate-planning attorney. But the client procrastinated. Today, the client is ready to transfer a 50% interest in the company to her son, but the company is now valued at $40 million. As a result, she will pay gift tax on a much larger taxable gift.
The Fix: Had the client transferred the half interest two years ago, she would have paid gift tax on only $10 million rather than on $20 million, thus avoiding the tax on the post-gift appreciation attributable to her son's half interest.
Mr. von Poblitz says that if an owner anticipates transferring ownership in the next five years, it may make sense doing it sooner at a lower valuation.
The Mistake: Incorrectly Valuing the Business
Richard Jackim worked with a client who was the founder of a small but successful consulting firm. The client calculated he'd need to sell his business for $6.25 million to maintain his lifestyle in retirement, says the Chicago-based exit-planning adviser, and figured his business would be worth that much. He was wildly optimistic, however. All too often, owners base retirement plans on faulty valuations, causing drastic overhauls in retirement plans, not to mention blows to self-esteem, says Mr. Jackim.
The Fix: Well in advance of retiring, business owners should get a realistic appraisal of their business, to see if it will fetch what they'll need to retire. If it won't, the owner needs to adjust his or her retirement plans, or come up with a financial strategy to boost their income.
Mr. Jackim says a mergers-and-acquisition adviser can help determine what a business actually might sell for.
Also essential: understanding if there is a market for the company, how liquid the market is for lending and equity, what buyers are paying for similar companies and how they are structuring the deals.
The Mistake: Rushing to Accept a Rich Number
Sellers often jump at what appears to be the highest bidder, ignoring other bids, says Fentress Seagroves, an Atlanta-based transaction-services principal. But that high bid may be misleading. The seller doesn't take into account the due diligence that the buyer is undertaking, and how that could change the final number. The seller also ignores other crucial elements of the bid, such as how employees will be treated, or how the buyer will finance the deal. In the end, the seller may have ignored what would have been truly the best deal.
The Fix: Don't fixate on what is superficially the richest offer, Mr. Seagroves says. Big numbers sometimes are used as a distraction. Stay engaged. Try to anticipate how the due diligence the buyer is undertaking could change his or her offer at the close. Consider all aspects of the transaction, not just the nominal price.
The Mistake: Hiring Your Brother-in-Law to Do the Deal
Thomas Bonney had a client whose legal counsel's expertise was in general legal matters for small businesses. The lawyer also happened to be the husband of the company's controller, says the Philadelphia-based exit-planning adviser. The lawyer's lack of expertise with merger-and-acquisition transactions and lack of understanding about the time-sensitive nature of the deal resulted in the family's missing the opportunity to sell the business in a strong deal market.
The Fix: Too many family businesses keep everything in the family—including legal services. That can be fine, day to day, but foolhardy when looking to sell. Mr. Bonney advises clients who are considering selling their business to interview three to five separate firms early in the process. He says they should ask the lawyers how they would structure the deal, how they can help with negotiations and ultimately, make a quick close. This process will not only allow the owner to see how an attorney works with them, but they will also have an opportunity to get some good ideas on both legal and personal issues—such as what should a compensation package look like for a family member who wants to continue to work in the business.
The Mistake: Underestimating the Emotional Impact of Selling a Business
John Leonetti, a certified business-exit consultant based in Canton, Mass., has seen all manner of crises erupt when a business owner prepares to sell, causing disastrous moves that wound up hurting the sale and the seller's personal life. He's seen some owners fire their key people months before a scheduled sale, refuse to return phone calls that are time-sensitive and critical to the transaction, and act unreasonably during the negotiations. He's seen others engage in lavish spending sprees or file for divorce after a sale.
Because owners' sense of self and purpose is often wrapped up in their business, letting go is often more difficult then they realize and sometimes causes them to act irrationally, he says.
The Fix: Mr. Leonetti says owners can make their exit easier by mapping out their post-exit lifestyle before the sale. He advises clients to get a calendar and fill in how they are going to spend each day for the six to 12 months after the deal goes through. He's also seen clients do consulting work or start a scaled-down version of their former business, allowing them to stay in the business they love and adjust to a new schedule.
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Originally published May 9, 2012
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The views of the authors of these articles do not necessarily represent the views of First Republic Bank.