Warning: Your Business Is Not a Retirement Fund!

Many business owners are hugely successful but making big bucks doesn’t mean they’re preparing for retirement. Too many pump all their money back into the business, which can be a dire retirement mistake.

By Justin Goodbread, CFP®, CEPA, CVGA

published 11 December 2021

in Features

A coffee shop owner leans with her elbows on the counter with a worried look on her face.

(Image credit: Getty Images)

I often receive inquiries from business owners seeking to increase their company’s profitability, margin, etc. Many of them view the business as their retirement plan. Although it’s an asset you could use to fund your retirement, I believe focusing on profitability is shortsighted. By focusing on growing the bottom line, you’re creating a generous income for your present. But what happens once you’ve exited from the business? Unless you’ve increased its intrinsic value, making it an attractive option for buyers, it won’t sell for what you think it’s worth. Even worse, it may not sell at all.

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Therefore, don’t focus on increasing profitability. Instead, take a holistic approach that focuses on improving the eight key areas of planning, leadership, sales, marketing, people, operations, finance and legal. By improving each of these areas, you could grow the intrinsic value of the business far more than focusing on increasing profits ever could. Yet, as the business becomes more valuable, it typically becomes more profitable as well. But there is a catch.

By the Numbers

According to the Exit Planning Institute, up to 80% of businesses will never sell. That means that for every 10 business owners reading this, only two of them will be able to sell their business. Perhaps the most concerning part of that statistic is the fact that 80% of the average business owner’s net worth is tied up in their business. Therefore, when it comes time to retire, eight out of 10 business owners are going to find themselves losing 80% of their worth.

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The EPI estimates that out of the 351,000 businesses in the middle market, 250,000 — nearly 75% — will attempt to sell by the year 2030. Furthermore, it is anticipated that only 25,000 of those 250,000 businesses will be deemed market-ready when they do go on sale.

When we continue to follow this thread, the picture grows even more dire. A mere 15,000 of the 25,000 will actually sell. Half of the companies that sell will do so without concessions. Therefore, just 3% of business owners will sell their businesses without leaving money on the table in the next nine years. By these numbers, it becomes clear that if you invest all — or most — of your money back into your business you’re taking a massive risk.

It is this very reason that I say, “No,” when business owners come to me, seeking to increase their business’s profitability. We require all business-owning clients who want to employ us for Business Value Growth services to, first, engage us for personal financial planning. Why is this a requirement?

Investing in Outside Assets

As I already mentioned, the statistics surrounding the liquidation of or selling of a business are pretty bleak. Looking at the numbers, it’s clear that many business owners will be left unable to sell their businesses when they wish to exit. Although there are ways to grow the value of the business so that it could be sold, your financial planner must also prepare you for the possibility that your company won’t sell. Does that mean you shouldn’t focus on growing your business’s value? Absolutely not. Increasing the value of the company has benefits and merit regardless of whether it will sell. So how do you prepare for a future that doesn’t go according to your best-laid plans?

The answer is to create a plan B. You have to eliminate every risk in your path. Therefore, you must work with your adviser to put a contingency plan in place. This is why the personal financial plan is so important. Your business is an asset that could be included in your retirement plans. But the responsible thing to do is to diversify by investing in assets outside of your business. You don’t want to be stuck with all of your eggs in one basket.

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It’s highly unlikely that your adviser would place all your money into a single asset class. They would be responsible for a catastrophic loss if that asset class suddenly crashed. In fact, I would suggest that they would be derelict of their duties if they did such a thing. Yet, this is exactly what is happening if an adviser allows you to invest solely into your own business.

As financial advisers, part of our duties is to educate clients about the necessity for diversification. This is especially true for business owners. Oftentimes, you don’t look at your business in these terms. It’s time to change your perspective. Rather than seeing your business as the path to the future you desire, you must see that it’s merely a part of that path. The personal financial plan includes the safety net of diversification, so you don’t have all of your eggs in one basket.

Tax Mitigation: A Major Incentive for Business Owners

As a business owner, you can do things with investments that are outside of your business that you just couldn’t accomplish otherwise. For example, by investing a portion of your profits into retirement accounts, you could be investing your most heavily taxed income to greatly mitigate your immediate tax burden.

If you’re in a 27% tax bracket (paying yourself first), by investing funds into retirement accounts, you could effectively remove the funds you’ve invested from that 27% tax burden. By removing the highest taxed funds, you could potentially move yourself into a 15% bracket. Notably, you could also reduce your tax burden on the funds that weren’t placed into retirement accounts, as well.

I have seen tax reductions through proper investing provide an instant ROI of 30% or more, just because of the tax effect. On that basis alone, you’d be hard-pressed to show such an immediate return on investment by reinvesting funds into the business — barring bonus depreciation, which opens another long-term tax concern.

Hard numbers such as these speak volumes. If you’ve been hesitant, perhaps you’d be more inclined to look outside of your business when looking at immediate benefits like this. If you can mitigate your tax bill through smart planning, you can build greater wealth. In turn, this could be used to further diversify, placing you in an even better position for your retirement plans.

The Holistic Approach to Retirement Planning for Business Owners

This is why I require business-owning clients interested in Business Value Growth services to engage with personal financial planning as well. It isn’t a self-serving policy. Instead, it is born from a desire to see you succeed. Although I’ve had clients who didn’t understand this policy when it was first presented, they’ve typically embraced the structure once they understood the big picture and the direct effects.

Owning a business is great. It typically generates an income that can’t be matched by working for someone else. However, it’s my job, as a financial planner, to show you how you could reach your goals under all circumstances. Once you understand how personal financial planning lays the foundation for growing the value of your business, you unlock the potential to experience rapid net worth growth.

On many occasions, I have seen business owners double their net worth every three to five years through comprehensive personal and business planning. Of course, there’s no guarantee that you would experience the same results. But by creating a comprehensive personal financial plan, your financial adviser can help provide a safety net for your retirement in case your business doesn’t sell.

Instead of betting all of your hopes and dreams on the sale of your business, you can use the business as a vehicle to help reach your retirement goals. But it must be part of (and not the foundation of) a larger retirement plan. Investing all your money into the business and focusing solely on increasing profitability will lead to a disastrous end more often than not. You might earn an incredible income while you’re working in the business, but when it’s time to retire, that income will no longer be there.

By investing outside of your business and working to improve its intrinsic value, you set yourself up to reach your retirement goals, regardless of whether your business sells. However, you also stand a much better chance of selling your greatest asset… your business.

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Disclaimer

Certified Financial Planner Board of Standards Inc. (CFP Board) owns the CFP® certification mark, the CERTIFIED FINANCIAL PLANNER™ certification mark, and the CFP® certification mark (with plaque design) logo in the United States, which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Justin A. Goodbread is a CERTIFIED FINANCIAL PLANNER™ practitioner and an adviser with WealthSource® Knoxville. After years of working in a large firm, he ventured out on his own in 2009, starting Heritage Investors, and eventually joining WealthSource® Partners LLC in 2022. As a serial small-business owner, Goodbread has bought and sold multiple businesses. He uses this experience, along with his continuing education, to help business owners grow and sell what is often their largest asset.