Business Owners Have Unique Financial Planning Challenges

Sep 22, 2021

By Eric Estelle, Manager, Financial Planning & Marketing

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Everyone can benefit from having a financial plan in place, but for business owners it is especially important. Owning a business requires a huge time commitment and laser focus to be successful. Being primarily focused on building and managing a business can cause long-term planning to get put on the back burner. Since profits are often funneled back into the business to foster growth, it is easy for a business owner to find themselves approaching their desired retirement age with little in liquid assets. It is common for the value of the business to represent the largest part of the owner’s net worth, and this can cause some unique planning challenges.

Retirement for business owners doesn’t always mean the same thing as it would for a typical worker. When the average worker retires, it is a clean break from their employer. However, for a business owner, it is not so simple. Some owners might not ever fully retire, instead opting to take a step back while still maintaining ownership and collecting income each year. Others may plan to pass the business to the next generation or a key employee. An outright sale is another possibility. Since the value of the company is often the largest asset in the portfolio, it is important to know how each of these scenarios might impact retirement. Working with a financial advisor to build a comprehensive plan will allow for all likely scenarios to be compared side-by-side. These comparisons will show which scenarios are likely to result in a successful retirement and which might not.

Risk management, or insurance planning, is another important component that can be more complex for business owners. For instance, life insurance can play an important role in multi-owner businesses to fund what is known as a “buy/sell” agreement. Later this month, there will be a more detailed article discussing buy/sell agreements. In short, these agreements can reduce the risk of a partner passing away, and they also establish what happens to the decedent’s share of the business.

The death of a business owner presents a substantial risk to his or her surviving family as well. This is especially true if the bulk of a family’s net worth is tied up in an illiquid business. For example, it is possible that a company will need to be sold quickly to pay off debt, pay estate settlement costs, and provide for the surviving family’s living needs. This quick sale might mean the business is sold for significantly less than its market value. Having the appropriate amount of life insurance in place can provide the liquid assets needed and avoid having to sell the business at a discount.

In addition to an unexpected death, business owners should also plan for a sudden disability. If an accident or illness were to prevent someone from operating their company, income could be reduced or stop altogether. This sort of an event could be detrimental if there are not enough liquid assets to close this income gap. A wholistic financial plan will address these issues and determine if life or disability insurance is necessary and how much coverage is needed.

Estate planning presents challenges for business owners as well. Again, the primary complication comes from the illiquid nature of business interests and the business typically representing a large part of overall net worth. A clear succession plan for the business will likely be a focal point of the owner’s estate plan.

One potential obstacle is estate equalization. Often, one child is heavily involved with the business while their siblings are not. If the business will be inherited by one child and not others, it can be difficult to divide the remaining assets in a way that makes everyone feel they received an equitable share. Additionally, strategies exist that are specific to business interests that might mitigate federal or state estate taxes. These strategies can be complicated and might require annual gifts of business interest or other actions be taken annually to be effective.

Retirement, insurance, and estate planning are just a few of the complexities business owners might face. It’s nearly impossible to address it all alone. A successful business sale or strategic exit can be as challenging as owning and operating the business. Working with a financial advisor to put a plan in place is a great step toward finding the best way forward. A team approach can produce the best overall results, by keeping your financial, legal, and tax advisors on the same page.