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How to Create Your Small Business Retirement Succession Plan

Rebecca Lake

When it comes to retirement and succession planning, a recent Wells Fargo/Gallup Small Business Index survey suggests that business owners aren't necessarily as prepared as they ought to be. Seventy percent of business owners surveyed say they don't have a formal written plan in place outlining what they'll do with their business if they decide to retire or can no longer continue working.

"Ideally, the best time to develop your exit strategy for retirement is the day you open the business," says Joe Fahey, senior business transition strategist for Wells Fargo Private Bank in McLean, Virginia.

If you own a small business but you've given relatively little thought to how you'll handle the shift into retirement, now's the time to begin working on your plan.

Identify your end goal. Before you can begin creating your succession road map, the first thing to consider is what you plan to do with your business.

Brian Pearson, president and CEO of American Benefits Exchange in Austin, Texas, says if selling is on the horizon, it's important to leave room for flexibility in your plan.

"One of the things I think is paramount, even before looking long-term at the sale of a business, is knowing that things can change," Pearson says. "Small business owners can't rely solely on the money from selling their business [to fund their retirement]."

Pearson says small business owners need to maximize all the retirement savings options available to them, including individual retirement accounts and 401(k)s, as well as funding taxable investment accounts.

[See: 10 Tips to Boost Your IRA Balance.]

"It's important to have a backup plan or a safety net, should things not play out as intended with the business," Pearson says.

Mark Tepper, a certified financial planner and president of Strategic Wealth Partners in Independence, Ohio, says one potential roadblock to proper planning lies in how some entrepreneurs view their business.

"Way too many entrepreneurs operate their businesses with the primary goal of generating cash flow to sustain their lifestyle," Tepper says. "A business should be viewed as an investment -- something that will have real, tangible value."

Tepper says getting a start on succession planning as early as possible can ensure that you have enough time to improve inefficiencies in the business so that when and if you opt to sell, you can land the highest sale price.

Choose your investments carefully. If you've decided that selling your business is the right path, it's important to think about how you'll invest the proceeds as part of your larger retirement strategy.

Ben Gadon, managing director at CBIZ MHM in New York, reminds small business owners to keep diversification firmly in sight. "Leaving all of your eggs in one basket is not a good idea," Gadon says. "Once you monetize your retirement, you want to keep it on the path of continued, steady return with minimization of volatility. Diversification is key."

Tepper says a well-designed financial plan should indicate the required rate of return your portfolio needs to generate for your money to last throughout your lifetime.

"Once that's determined, it's important to build a portfolio that minimizes volatility and draw down," Tepper says. "It's been proven through simulations that minimizing volatility is more important than gross rate of return when it comes to capital preservation during the distribution phase of retirement."

Fahey says a sound approach would be to develop a keep-versus-sell snapshot of your financial picture before pulling the trigger on a sale. That means examining your financial balance sheet, cash flow, liquidity and risk profile on a before and after basis.

"Often, clients are surprised by the cash flow decline after they sell the business," Fahey says. "If the price is insufficient to meet your financial objectives, you may need to continue to invest the excess cash flow for a few more years, then sell."

Fahey also says business owners should be mindful of a sudden shift in the liquidity of their portfolio, as well as the condition of the markets.

[See: 9 Ways to Avoid 401(k) Fees and Penalties.]

"If you sell your business at the peak of the market, pay taxes and invest the net into an all equity portfolio, you run the risk that the liquid portfolio may hit a downturn in the cycle," Fahey says. "If you have a long-term time horizon, take your time and develop a long-term strategy to dollar cost average and transition from all cash into the optimal asset allocation that meets your income and risk profile."

Cover all the bases. Having a succession plan in place is a step in the right direction but you need to be sure that you're prepared for more than just the transition to retirement.

Michael Beriss, an advisor with Ameriprise Financial Services in Bethesda, Maryland, says having the right type of insurance coverage can minimize the potential for unexpected setbacks.

"Insurance can be a powerful tool to both provide protection and help the business transition," Beriss says. "Key person life and disability insurance can provide the company with money to help replace critical employees if they die or become disabled."

For example, you may choose to purchase a life insurance policy for yourself as part of a buy-sell agreement, with the buyer serving as beneficiary. This would ensure that the buyer has the money to purchase the business if something were to happen to you prematurely.

Mike Repak, vice president and senior estate planner at Philadelphia-based Janney Montgomery Scott, says that that regardless of whether your business is organized as a partnership, LLC, S-corp or C-corp, a buy-sell agreement should be part of the succession planning discussion.

"Although the plan may be to continue the business, questions around what happens if this proves to be impossible should be addressed sooner rather than later," Repak says.

[See: 10 Skills the Best Investors Have.]

Repak says there are additional reasons to consider putting a buy-sell agreement in place. He points to disability, divorce, bankruptcy and criminal conviction as scenarios where a buy-sell agreement would offer protection to the business and its owners.

Don't just set it and forget it. One important caveat to keep in mind is that succession planning is not so much a once-and-and done proposition as it is a fluid and ongoing process when you own a business.

"It's important for small business owners to revisit their succession plan often," Pearson says. "Things can change in terms of who the partners are, where the business is located and the value of the business. It's not just a one-time event, but it's something you want to go back and update to make sure everything that was done legally is still suitable and makes sense for the business."

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