Depending Too Much on Your Firm to Fund Your Retirement
By David R. Peters, CPA
Succession planning is tough. There are so many things to think about. How do you select the next person to move the firm forward after you leave? How do you warm up suppliers and customers to new faces of leadership in the office? How do you keep employees motivated and maintain their support? Succession planning is time consuming. A common rule of thumb that has been espoused in various financial publications is that succession planning takes approximately 2 or 3 years. However, more thorough and academic approaches to the topic suggest a much longer time frame. For example, using the findings of over 400 academic articles, Ip and Jacobs (2006) suggest that succession planning takes up to 10 years. The same authors also suggest that the average time period for a new leader to operate at his/her full potential can take an additional 12 to 18 months. While presumably there is some variation from one industry to the next, the bottom line is that transitioning out of a business takes careful planning and effort. It is not something you can just jump into. Perhaps it is for this reason, that succession planning is so overwhelming. As CPA’s, we know the importance of succession planning. In a recent AICPA survey, 93% of firms surveyed felt they needed a written succession plan. However, only 46% of these firms actually had a written and approved plan in place (Succession Institute, 2012). Even we CPA’s wait, because the thought of succession planning is just so big. It involves every facet of our business, and in our busy lives, there may never seem like a good time to do it. So we just wait.
For the owner of a small CPA firm, the problem of waiting is more complicated. For most small business owners, the bulk of their wealth is tied up in the business. Simply put, by waiting to engage in the succession planning process for the firm, the small business owner is waiting to plan for his/her own retirement. The small business owner may find himself/herself in a situation where the only asset they have to fund their retirement is the business itself. While this may not sound bad on the surface, it can be incredibly problematic. In most small businesses, the owner of the firm has value. He/she has relationships with suppliers and customers, industry knowledge, and a reputation within the community. The value of the owner is not lost on the buyer, who usually looks at the business as being worth far less without the owner being a part of it. Aside from this, most small businesses are not known outside of a certain area. This limits the number of potential buyers, which may drop the selling price of the firm even further. In finance, the term for this is lack of marketability. People are less likely to pay large sums of money for a firm, when they are unsure of their ability to sell it later on.
In short, there is a significant problem when a small business owner is depending heavily on their business to fund their retirement. Once one discounts the selling price for the removal of established firm management and the lack of marketability, the firm may command a much lower price than initially expected. This is a huge risk for the small business owner. It can mean the difference between a comfortable retirement, and one where money is tight. It is the equivalent of having a retirement portfolio of only one stock. If the stock goes down, the small business owner is sunk!
Luckily though, the solution is simple—diversify the portfolio by having other retirement savings that don’t depend on the selling price of the business. One way to do this is to begin a company 401K plan. The small business owner can utilize the plan to build retirement assets outside of the business, thereby lessening the need for a high selling price from the business. While the cost of such a retirement plan can be a concern, there are some plans that can be affordable for even small CPA shops consisting of only a few employees, and catered to their needs.
The key is that small business owners must realize the inherent dangers of putting all their eggs in one basket when it comes to retirement planning. If the business doesn’t sell for what he/she thinks it should, the small business owner needs to have a Plan B. Developing a retirement plan, such as a 401K, can help appropriately diversify the risk in a small business owner’s portfolio. It is a natural part of good succession planning for the firm, because it will help the business owner be under less pressure when going through the selling process. Not to mention it will help the small business owner achieve his/her retirement dreams.
As originally published on CPA.com
The information discussed herein is general in nature and provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Nothing in this article constitutes an offer to sell or a solicitation of any offer to buy any type of securities.
Registered Representative of and securities offered through Cetera Advisor Networks, LLC, Member SIPC/FINRA. Advisory services offered through Carroll Financial Associates, Inc., a Registered Investment Advisor. Carroll Financial and Cetera Advisor Networks, LLC are not affiliated.
Ip, B., & Jacobs, G. (2006). Business Succession Planning: A Review of the Evidence. Journal of Small Business and Enterprise Development, 326-350.
Succession Institute. (2012). 2012 PCPS Succession Survey: Gearing Up to Wind Down. New York: AICPA.