Why You Need to Plan for Retirement
When do you want to retire? Is there an age or benchmark that you want to reach before retiring?
Retirement is not like selling a car, it is not a transaction that can be prepared, marketed, and sold in a couple of weeks or even a few months. Based on when you want to retire, you should start your retirement planning 3 to 5 years in advance. Oftentimes, a contractor is the sole owner of their business, so to retire they must prepare themselves and their business for the transition.
There are three main reasons you need to start planning your retirement up to 3 to 5 years beforehand:
- Separate yourself from the business
- Prove profitability
- Establish a business location
1. Separate Yourself From the Business
Construction businesses are built on trust and reputation, and more often than not, this is developed through personal business relationships between the owner and the clients. The owner quickly becomes the face of the business therefore the person the industry associates the quality of work with, so the reputation is not built upon the company name but rather the owner’s name.
If the owner was to leave, it could cause current clients and people in the industry to not hold the same trust in the business because the construction business’s inflow of work was reliant on the owner.
If you plan to sell your business you need to increase its value by building its reputation based on the business and the team. To do this, the owner must slowly separate themselves from the business. This transition cannot be accomplished overnight, it requires time so the industry can start recognizing the quality the business brings, not just the quality the owner brings.
2. Prove Profitability
As an owner-operator business, most contractors try to keep their profitability low to reduce steep taxes. It is a strategy used among many contractors that allow businesses to operate with maintainable expenses. Yet, because of this strategy, the tax forms and profitability records will show a different story about how profitable the business is. While this does not impact the owner’s everyday operations, it can hinder the ability to sell your business at the value it is worth.
When a contractor chooses to sell their business, the investor will want to see the past 3 years of profitability. This means that in the 3 to 5 years leading up to your retirement, you need to shift your business strategies so that your financial records show your accurate profitability. While this means paying more in taxes for those years, it sets your company up to be sold at the price it deserves.
3. Establish a Business Location
Contractors will often run their business from their homes because it saves time and money by operating out of your house or garage. Yet when looking to retire, the physical location of your business is important. It gives the new owner a physical location they can take over that signifies the purchase of the business. It also is a way to further separate yourself from the business.
Finding a rental office, moving to a new location, or improving your current office space is not something you want to be doing at the same time you are transitioning out of your business. Preparing 3 to 5 years in advance will ensure this adjustment is established before focusing on transitioning from the business.
In order to prepare for retirement, you first need to determine what retirement plan is best for you and your business. Below are questions to ask yourself when beginning your retirement planning process.
What is Your Retirement Plan? Questions to Ask Yourself
Have you determined what is your retirement plan? As an owner-operator business there are 3 main options for retirement:
- Sell your business
- Giving or selling business to family, typically a child
- Closing the business
Determining which route is the best for you and your business is the fundamental step for determining your retirement plan. Below are three steps with questions to ask yourself to figure out what route to take to help with retirement planning.
1. How much do you rely on your business to fund your retirement?
Does your business need to continue generating an income to support you and your family after retirement?
If yes, evaluate how much money you relied on the business throughout the year to fund your everyday life, and then determine what percentage of that you would need for retirement.
If you have a child that is willing to purchase or inherit the business and it is a part of the contract to have a set amount allocated to you every month or year, how well is your business set up to support both yourself and your child? If you expect to receive a certain amount of money each month, how much would be leftover for the current owner based on the profitability from the last few years?
In comparison, if you choose to sell your business to an outside buyer, how much are they able to finance the purchase up front, and how much will be under a repayment plan? If there is a large repayment plan that you will rely on to finance yourself after retirement, is the buyer capable of continuing a successful business and generating enough revenue to pay you?
If you are not relying on your business to fund your retirement, then you do not need to worry about the previous situations to the same degree. By removing future reliance, it opens the opportunity to more freely choose between selling, giving to a child, or closing the business.
2. How much is your business worth?
This question relates to the reasons to prepare for 3 to 5 years, each of those steps contributes to increasing the value of your business. Separating yourself from the business safeguards future sales to maintain current value, proving profitability will provide financial records of profitability, and establishing a physical location will give the new owner a facility to run their purchased business.
If you believe that the above steps will not increase the value of your business, then it worth considering the option to close your business. Deciding when to close a business is a difficult decision, although when retiring it is a valid option. If your business does not have any assets, patents, tools, unique selling points, recognizable name, etc., then it lowers the selling value of your business; ultimately making it a better business choice to close the business.
3. Should you do a stock sale or asset sale?
Let’s say your business does have a few valuable assets, patents, tools, etc. but overall the business does not uphold the same value, then you could consider selling as an asset sale. This means you can sell certain assets as individual sales rather than the entire business as a single sale which would include all the assets, called a stock sale.
Depending on the overall worth of your business, it will influence how you should sell. If your business is worth a large amount even accounting for the less profitable portions, then a stock sale can be the better option.
If the cons do not outweigh the pros of your business, then selling your business assets as individual sales will be the best route. Assets can include equipment, website, customer list, business name, etc.
Help with Retirement Planning
Minnesota Construction Law Services (MNCLS) is a long-standing construction law firm that provides business consultation for contractors at each stage of their business. Our team has experience in both business and construction, so we understand the steps that go into running an owner-operator business.
We have assisted contractors to prepare and navigate retirement from selling their business, giving it to a child, or closing the business. Ask our team your questions, and we will work with you to put a game plan together for a successful transition, no matter where you are at with your retirement plan.