Eric was a gifted acoustic engineer. He could make things work when no one else could. Feeling stifled by his employer, he left to start his own business. He capitalized on a niche market and built a successful company along with a national reputation in his field. Along the way, he hired a key employee, Andy, who was to be his ultimate successor. Eric promised Andy 25% of the company as an incentive to stay with him. At the time, Eric wasn't concerned about giving part of the company away since it was easy to give away 25% of the company when the company was worth nothing. As the company grew, Eric enjoyed the financial fruits of his labors. When he over spent his salary, he just took what he needed from the company account. After all, it was his company and his money. After a while, he was spending more money than he or the company had and became very accustomed to a high standard of living. Everything was fine until two things happened: Andy wanted the 25% of the company Eric promised to him, and Eric wanted to retire.
Your exit from your business should be determined by you, not by external circumstances.
Unfortunately, most owners do not take the time to plan for their ultimate exit from the business, whether it is voluntary — like through a sale or retirement — or involuntary — like through death or disability. Regardless of how you ultimately leave your business, the lack of proper planning extracts a terrible toll on you as the owner, your family, and your employees. The day you start your business is the day you should begin your exit planning. Unfortunately, the business takes on a life of its own, and you get consumed in the day-to-day operations. Author and lecturer Denis Waitley says, “The urgent always calls, the important never does.” So it is with exit planning. When starting or running a business, the thought of exit planning doesn’t compare on the urgency scale with activities such as meeting with customers, fulfilling orders, or paying employees. On the importance scale, though, lack of a structured exit plan could spell a horrible ending to a flourishing business.
Poor exit planning runs rampant amongst today’s business owners. Check out this Inc. magazine quote:
“I saw the previous owner of this company get to the point where at age 65, he was desperate. He had done nothing to prepare for his retirement, he had no succession plan, he was vulnerable because of his age, and all his assets were in one place. I thought to myself, I hope I learn something from this.” (Billye B. Erickson, president-owner of Capso Sales Inc.; Inc. magazine, April 1986)The story of Eric and the one above have much in common. Neither business owner had planned for their business exit, both had all their wealth tied up in their business, and both waited too long to plan. Their options were limited and costly — years of hard work down the drain.
You need a well thought out plan to ensure you leave on your terms.
One thing is for sure. One day — whether because of death, disability, or retirement — you will exit your business. Do you have a plan to take your money with you on a favorable basis? It takes time to plan and execute a successful business transition. Depending on your objectives, it may take three to 10 years to leave on your terms. When you wait until the last minute to plan, your options can be limited, and decisions made in the interest of expediency can create horrendous tax nightmares. But even the best-intended plans can be disastrous when all of the implications aren’t thought out. Check out this example of a well-intended plan going bad, which created significant hardship for the owner:
Bill wanted to retire. He wanted to either sell or liquidate his business, so he converted his C corporation to an S corporation. This can be a good strategy because a C corporation is a separate tax entity. If, as a C corporation, the business were to be liquidated, the corporation would pay capital gains tax, and when the proceeds were distributed to the owner, he would pay capital gains tax as an individual. An S corporation, however, is taxed on an individual basis. By converting to an S, the business owner stood to save a ton of taxes because he would only pay tax as an individual. Unfortunately, his C corporation had retained earnings and profits which remained after the conversion. The end result after converting his C corporation to an S corporation was a huge, unsuspected, and unplanned tax bill on the retained earnings and profits. To add insult to injury, the conversion was irreversible because he had already completed the transaction before he discovered his error. Had he taken the time and sought good counsel, this problem could have been avoided.
Need more? Check out www.smallbizmadesimple.com for some great resources to help you be a more effective small business owner.
About the Author
Tom Fowler is the president of the Fowler Financial Group and has over 40 years of experience in assisting owners of closely held and family-owned corporations in business and estate planning. Tom is the creator of The Business Exit Strategy Solution™. He has authored numerous articles regarding business and estate planning issues. He is a frequent speaker throughout the country, and he hosted a weekly radio show entitled “You and Your Finances,” sponsored by the American Society of Financial Services Professionals. He is a Charter Faculty Member and Certified Wealth Consultant for the Heritage Institute, an educational non-profit organization.
Contact Tom at tom@smallbizmadesimple.com.
