By Michael G. Skowfoe
You may be wondering what to do before selling a business when it comes to your personal finances. There are key areas that we’ll touch on in this article, including your personal financial goals, legacy plans, personal tax planning, and how your retirement or benefits may change post-sale.
Like many small business owners, you’ve probably engaged in business planning to help you get your business moving in the right direction and on track. But how confident are you that your personal and business plans are set up to deliver the results you expect, want, or even need as you prepare to exit your company? If you’re not a hundred percent certain your plans will deliver as expected, it may be time for a stress test.
What is a stress test? Stress testing is a process that carefully examines your business and wealth planning efforts to determine the efficacy of the strategies that you have in place and how they will carry out as you intended under various scenarios. A stress test can help determine whether your planning will deliver the outcomes you desire.
Stress testing focuses on results, not products or tools. The desired outcome is to identify gaps or obstacles that stand in the way of what you’re attempting to achieve with the planning currently in place.
Although there are a number of areas a stress test can and should focus on, it really comes down to what is most important to you as the business owner. A financial advisor that specializes in working with business owners can help you identify the areas needing the most attention. However, the following are a few key areas to stress-test.
Your Exit Plan and Taxes
First would be your exit plan and taxes. When considering the exit from your business, minimizing future estate taxes can be a major component of exit planning. Unfortunately, many business owners are busy, and they miss this early planning opportunity and later regret not exploring it sooner when they discover the tax bill they are facing.
This step should be highly coordinated with your personal estate planning wishes. When given enough time, strategies can be implemented to allow you to walk away with more from the sale, with money potentially going to your family members versus the IRS.
The next area would be retirement planning. Many business owners have qualified retirement plans in place, and for some companies, those plans may not be viable. In some cases, certain qualified retirement plans would be very appropriate but never offered to business owners.
It’s important to understand what your ideal lifestyle requires. Do you have the plans in place to receive the funds and have them managed in a way that meets your risk tolerance and lifetime financial goals?
Are there strategies that can be implemented pre-sale, depending upon the amount of time you may have before a sale, that could (1) potentially reduce taxes and (2) continue to build your retirement nest egg? It is essential to understand what you need to live your ideal post-business owner life.
There’s a concept known as a war chest, and the war chest is how many years’ worth of spending you want to have in cash and cash equivalents. It is important to understand what it costs to live your ideal life because this will help you understand the amount to place into the war chest.
So think of it as a barbell—you’ve got a war chest of cash and cash equivalents, and then on the other side of the barbell, you have your investments. And the investments will move up and down over time, but to meet your daily lifestyle needs, you’ll be depleting your war chest, and the idea behind your investments is to replenish the war chest over time.
The next area is looking at your overall debt situation. While you’re employed and owning the business, does it make sense to potentially look at any outstanding liabilities that you have? Should you explore whether refinancing makes sense? Are there any charitable contributions you would like to support in the community, and how would they impact your tax planning?
The next area would be to understand your legacy plans. How will the sale of the business affect your personal estate plan? Is your personal estate plan positioned so that it carries out your wishes?
Do you have a good understanding of what it requires for you to live your ideal financial life? If there’s excess, should strategies be employed to carry out other family or legacy goals that you have? What impact does the sale of the business have on the estate plan already in place, and does it need to be modified or amended?
Have you considered family gifting? Depending on the amount you’re selling the business for, it may be appropriate to help with lifetime tax planning. You may consider taking advantage of some creative estate planning techniques to lower your overall lifetime tax bill, but also carry out some of the legacy wishes that you have, potentially gifting to the family as a result of selling the business.
Will the family be involved in the sale? Do they have any ownership or ongoing management due to the sale?
As a business owner, you’re also probably known as the family steward, someone who wants to take good care of their family, provide for them, and help set them on their own paths to success. It’s a big reason why estate planning—how you transfer your wealth—is crucial for all successful business owners.
It becomes even more critical to make sure that it is highly coordinated in the pre-sale planning process. You want to make sure that your loved ones are adequately provided for and taken care of after your passing and that your wishes are carried out as intended.
When an estate plan is done well, the planning allows you to pass on your assets as you see fit. It also minimizes any state and federal taxes that might accompany very large estates, again, depending upon the amount of the sale of the business or what you’ve accumulated personally.
If you think your estate plan is up to those tasks, you might want to continually reassess. Tax laws change regularly, and what was relevant five years ago may not necessarily be appropriate today. So your estate plan may need to be at least looked at, stress-tested, and refreshed if necessary.
Personal Tax Planning
Another key area will be understanding how the business transition will affect personal tax planning. Is the timing of the transaction important to your personal tax status? Will the business sale be treated as capital gains versus ordinary income, and are there any techniques that could be employed to change that to a more favorable outcome?
Does it make sense to consider changing the ownership of the business in advance of a sale, and more importantly, do you have sufficient time for this to work effectively? Unfortunately, as I mentioned, this is an area that is often overlooked and discovered when it’s too late.
Individual Retirement Benefits
One last area to consider is how your individual retirement employee benefits will change post-sale. If you have qualified plans in place, you will begin the process post-sale of rolling over your IRAs. If they’re traditional IRAs, also known as pre-tax, they will go into an individual retirement account, or if considered a Roth, into a Roth.
Does it make sense to consider a Roth conversion? That means you would convert your pre-tax money to a Roth today, pay the tax, and have the assets grow without any tax consequences in the future.
What changes will need to be made to any type of life insurance that’s in place? If the business is sold and you monetize your life’s work by selling your company, is it necessary to keep your life insurance? And if so, is it the right amount? Should it be increased, or should it be reduced?
Another area to consider is health insurance. If you’re under a group plan, you’ll need to begin thinking about transitioning from group health insurance to securing an individual health insurance policy. There are open windows for enrollment, and those plans can be expensive, so it is worth spending some time to ensure that your health insurance will adequately provide for this need.
The Takeaway: In-Depth Planning Is Essential
You’re probably noticing a consistent theme in this blog for in-depth planning. We would recommend that the planning be coordinated with a full advisory team, including your tax team and legal team. We recommend that you consider putting a financial advisory team in place—one that is familiar with the needs and nuances of business owners and whether they’re headed down the right path. This would be something that we recommend in advance, and in some cases, years before the actual sale of the business.
So do you need a stress test? Stress testing requires some time and effort on your part, but it is intended to make sure that what you think will happen will actually happen. We think it is worth the time and energy to either confirm that you’re headed down the right path or that there are some things that should be tightened up or reconfigured pre-sale.
We offer an introductory call for business owners ready to transition their business. Get in touch with us for a complimentary consultation.