Financial Planning for Business Owners
and Entrepreneurs
The small business owner or entrepreneur faces many challenges. Often
financial planning is a neglected resource for small business owners.
• Over 50% of today’s 9.5 million business owners are age 50 or older -
AARP
• At any given time approximately 40% of U.S. Businesses are facing the
transfer
of business issue. The primary reason for failure is lack of planning. -
U.S. Small
Business Administration
• U.S. families have over $7.5 trillion tied up in private businesses –
The Federal
Reserve
So why do business owners tend not use financial planning. Some of
the most common responses are:
- The owner is too busy putting out fires and there is not enough
time to pay attention to future planning and the details of
succession, exit or transition planning
- The owner has advisors but often feel that the advisors are so
busy with their clients or working on specific “emergency projects”
that they don’t have time to help the owner proactively plan for the
future
- They seem to spend a lot of money on insurance, employee
benefits, and other things that benefit the employees of the company
but are not sure that those plans are coordinated or that they are
getting the best value for their dollar.
- They seem to be busier than ever. They just want to transition
from“Overtime” to “Part-time”.
Another common complaint from business owners is that their financial
planning advisors, whether they be a CFP, a CPA, or other planning
advisor, does not seem to understand the nuances of being a business
owner. In other words, the planner seems to talk to the employer as if
they’re just another employee, offering suggestions such as put more
money into the 401(k) plan and diversify your assets outside of the
business instead of helping the business owner to achieve what they
really want which is financial freedom from the eventual sale of the
business (or a very high-paying, very part-time job as they transition
to absentee ownership). Most planners fail to acknowledge that the
business owner has “body parts” in the business and that it represents a
lifetime of sacrifice and dedication. They are constantlybeing forced to
share with employees who are ungrateful and unthankful, with
thegovernment who is demanding an ever-increasing share to pay for
benefit programs but will probably pay little back to employees, and to
insurance companies who seem to continuously ask for more and more from
the business owner to protect employees’ welfare benefits.
Some suggested Planning Areas:
.
Planning Area #1.
Analyze various ways to get money into a Qualified
Retirement Plan
Typically we come into situations where a business owner is not able
to put much into a 401(k) plan. Of course, general employees earning
under $100,000 can put a large percentage of their pay (up to 100% not
to exceed $15,500 in 2007, unless they’re over age 50 in which case they
can contribute $20,500). But the business owner and other highly paid
employees of the company are often restricted as to how much they can
put in due to the 401(k) plan Average Deferral Percentage and Average
Contribution Percentage tests. If the business owners do not want to be
restricted by these tests, they have to share an immediately vested
match with employees of the first 4% of their pay. Talk about a
government mandated wage increase! It is not uncommon for us to test out
the overall costs of the “match” for these types of arrangements and
find that the business owner gets less than half of the contribution
himself, in which case it is typically a better idea for the business
owner to continue to grow their business by reinvesting in the business,
or take an after-tax distribution, pay their 40% tax and end up with 60
cent dollars. However, sometimes the stars line up, and the owner can
put quite a bit of money into a plan with less costs going to employees
that the government would take in taxes. You usually never know until
the plan is tested, but many business owners have not had the tests run
in years and could
very well have put away hundreds of thousands of dollars into their
Qualified Plan.
More on Small business Retirement Plans
Planning Area #2. Make sure there is a
written succession plan and test it every few years!
Business owners need to think of their buy-sell agreement like a
business Will. The business is typically the largest asset of the
business owner. Yet most business owners tend not to have written
business continuation instructions in the form of a buy-sell agreement
(if two or more shareholders) or a written business continuation
instructions in the event of a sole shareholder situation. This is
horrible lack of planning that has turned many profitable well-run
operating businesses and forced them to close the doors in the event the
business owner dies without having communicated their wishes. Even when
a Buy Sell or Instructions exist, the formulas and provisions of such
documents are often out of sync with the changes that have occurred in
the business. Many times the document is silent on certain types of
triggering events (such as disability of a shareholder) and could lead
to very devastating results if the worst case scenario happens.
More on succession plans
Planning Area #3. Life Insurance analysis.
Nobody likes life insurance, but everyone likes cash, especially if a
devastating event has just occurred, like the death of an owner or key
employee. Life insurance policies provide cash at that moment, and
thecash can be used to:
- Pay the high cost of a headhunter to find a quality replacement
employee and lure
the employee in with a “signing bonus”;
- Pay down or pay off bank debt and prevent loans from being
called;
- Fund the provisions of a Buy-Sell agreement or Salary
Continuation plan and thus
protect families that may have been otherwise financially ruined by
the death of a
breadwinner;
- Provide funds for a “stay bonus” program to retain key employees
until the
company recovers from the event.
With the cost of term life insurance having decreased close to 40% in
the last five to ten years and the availability of cheap capital in a
contingency event like the death of a shareholder, I don’t understand
why more business owners have not taken steps to protect themselves,
their families and their partners. And if they have current policies,
they should be taken out of the bottom drawer every few years and
evaluated for efficiency give the recent round of policy expense
reductions.
More on life insurance
Planning Area #4. Analyze and project
capital needs at retirement to provide desired income.
Business owners need to understand what it will ultimately take in
cash to provide the income they will need at retirement, and then set
about implementing strategies to provide the cash flow at retirement.
Most owners tend to think short term about such matters as cash flow,
and tend not to focus on the long range planning that is needed to
develop a cash flow scenario. For instance, an owner can use business
profits to purchase “business usable” assets such as the business
property and equipment to set up retirement cash flows. He could also
set up arrangements to pre-pay future expenses and reduce the amount of
after-tax income he will need at retirement. Examples include paid up'
life insurance, paid-up long term care insurance and establishing a
Welfare
Benefit Trust to pay for uninsured medical expenses The owner should
also contemplate setting up arrangements to provide for post retirement
income from the business such as unfunded deferred compensation plans,
and royalties from trademarked or patented processes or procedures.
Planning Area #5. Valuation awareness.
Since the business is typically the largest asset of most business
owners, and will ultimately be the asset that is sold to produce the
capital needed to provide the owner’s financial security, it would
follow that most business owners should be keenly aware of the value of
their business and have a clear understanding of how they will be able
to sell the business for maximum value, right? Wrong! Most business
owners have not got a clue as to how their business will be valued or
the methods of valuing a business. Most owners do not realize that there
are
multiple potential valuation methods that can be employed to value their
business at any given time (based on the reason for the valuation and
the perspectives of the buyers). And most business owners do not
understand what it means to “run a business as if it is for sale” (as
opposed to “up for sale”). Why? Probably because most businesses are run
to support the owner’s lifestyle, and the biggest enemy is taxes
(Payroll, Federal & State).
Business owners need to be counseled that, depending on the Transfer
Method that they ultimately choose to sell their business (Liquidation,
Outsider Sale, Strategic Sale, Controlled Auction, Management Buy-out,
ESOP, etc.), their business will be valued in a certain way. There will
be a tax imposed on the sale in some way. And the new owners will
ultimately support the sale with the business cash flow. So it makes
sense to explore methods to reduce the taxes and cash flow drain of the
sale and maximize the after-tax value that ultimately hits the owner’s
pocket. And that takes planning well in advance of a sale event.
More on Business Valuation
Planning Area #6. Recruiting, Rewarding and
Retaining key personnel
This is the pathway to leveraging business growth and allow for the
owner to get back the time freedom they all crave. Most business owners
live for their businesses. But many are tired. Years of overtime have
taken their toll on the business owner’s enthusiasm. They want to
transition from Overtime to Part-time. At the same time, most owners pay
their Key Employees with a Salary and a Cash Bonus. In a sense, they are
teaching the employee all about their business, and then giving away
their cash to potentially empower and finance their competition. Most
key employees think they want to be owners (the E-Myth!). If the stars
line up where they are ready to go out on their own,they will do so – as
soon as the next bonus is paid! We work with owners to help retrofit
their compensation structures so that employees have 3 boxes of pay:
• Today Cash (Salary and Bonus)
• Tomorrow Cash (Deferred and “locked up” with a Vesting Schedule)
• Contingency Cash (available in event of Retirement, Death or
Disability)
The key to the “3 box” compensation method is to make sure the employee
understands what it takes to earn the Deferred Cash and make sure
whatever measure it is tied to is profitable for the owner as well. For
instance, it could be tied to an increase in company Revenues or Net
Profits. It could be tied to an individual’s performance (particularly
if in sales) or a Division’s performance. It could be linked to the
management of projects and people. Whatever it is, the “KPI’s” (key
performance indicators) need to be communicated to the employees on a
regular basis. We like to design programs with a “continual vesting
schedule”, where each annual contribution has a 3-5 year vesting chedule,
and the employee is always walking away from the last few years of
contributions. Then, as contribution amounts increase over the years,
the employee is very engaged and motivated to staying on with the
business as the owner begins to enjoy more time off. In many cases, the
accrued balance can be used by the employee to make a down payment to
the owner for shares in the business.
Planning Area #7: Play the course backwards!
I’ve heard that when Pro golfers(or their caddies) walk
a course prior to playing it, they will many times look at the
course from the hole backwards to the tee box. The idea is that it is
more important to first understand how to finish and then develop a
strategy to get there. Most business owners do not have a tremendous
amount of investment cash at their disposal while they are growing a
business. However, when a liquidity event happens, they all of a sudden
have numerous “new best friends” and they often are overwhelmed with the
choices of
how to invest their new cash. Work with business owners to help them
develop an understanding of how to create investment program with large
lump sums (received from sale of the business). This is not necessarily
risk capital! There is often an emphasis on lifetime income strategies
and tax minimization strategies. By helping them explore
strategies and options early on a planner will likely work with the
owner in the area of asset management for many years to come. As
Baby-Boomers begin to exit their businesses in staggering numbers, their
will be a premium placed on the owner’s advanced planning and
preparation in the areas of Succession, Exit and Transition . The above
planning areas are meant to briefly summarize some of the key strategic
planning exercises that I believe will help the planning practitioner to
maximize their value to the business owner.
More topics
8 Tips to make
you financial plan profitable
Cashflow Basics: The
10 Rules of Cashflow
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