RETIREMENT REALITIES FOR BUSINESS OWNERS

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1 Business Owners Guide to Retirement Planning TOPICS 2 Introduction RETIREMENT REALITIES FOR BUSINESS OWNERS We are committed to providing resources, insights and guidance about retirement planning to owners of businesses and other enterprises. 3 Real steps to consider 4 Determining the value of your business 6 Positioning your company s value in a saturated market 7 Striving to protect the future value of the business 8 Diversifying your retirement income 9 Finding a buyer: Consider your options 10 The emotional challenges of leaving your business 11 Family business, family harmony: The delicate balance 12 Retirement for farm and ranch owners 13 Start planning now 14 Making retirement a reality: The strategic resources of U.S. Bank

2 Investment and Insurance products and services are: Not a Deposit Not FDIC Insured Not Guaranteed by the Bank This material is based on data obtained from sources we consider to be reliable. It is not guaranteed as to accuracy and does not purport to be complete. This information May Lose Value Not Insured by Any Federal Government Agency is not intended to be used as the primary basis of investment decisions. Because of individual client requirements, it should not be construed as advice designed to meet the particular investment needs of any investor. It is not a representation by us or an offer or the solicitation of an offer to sell or buy any security. Further, a security described in this publication may not be eligible for solicitation in the states in which the client resides. Asset allocation and diversification does not ensure a profit or protect against a loss. Past performance is no guarantee of future results. Current performance may be lower or higher than the performance data quoted and you may have a gain or loss when you sell. Non-qualified withdrawals are subject to all applicable federal and state income taxes, and may be subject to a 10% federal penalty. There is no additional tax benefit for annuity contracts purchased in an IRA or other tax-qualified plan, since these are already afforded tax-deferred status. Thus, an annuity should be purchased in an IRA or qualified plan only if the client values some of the other features of the annuity and is willing to incur any additional costs associated with the annuity to receive such benefits. U.S. Bank, U.S. Bancorp Investments, and their representatives do not provide tax or legal advice. Each individual s tax and financial situation is unique. You should consult your tax or legal advisor for advice and information concerning your particular situation. Insurance guarantees are backed by the claims-paying ability of the issuing insurance company. For U.S. Bank: U.S. Bank is not responsible for and does not guarantee the products, services or performance of U.S. Bancorp Investments. Credit products are offered by U.S. Bank National Association and subject to normal credit approval. Deposit products are offered by U.S. Bank National Association. Member FDIC. For U.S. Bancorp Investments: Investment products and services are available through U.S. Bancorp Investments, the marketing name for U.S. Bancorp Investments, Inc., member FINRA and SIPC, an investment adviser and a brokerage subsidiary of U.S. Bancorp and affiliate of U.S. Bank. Insurance products are available through various affiliated non-bank insurance agencies, which are U.S. Bancorp subsidiaries. Products may not be available in all states. CA Insurance License# OE RealSteps>Retirement is a registered trademark of U.S. Bancorp.

3 Business Owners Guide to Retirement Planning Introduction Congratulations! You ve worked with passion and vision to establish your own successful business. Your enterprise makes a unique contribution to your community, while providing you and perhaps other family members and employees with a livelihood. That is, and should be, a tremendous source of pride. Successful entrepreneurs have devoted much of their lives and passion to their venture, often resulting in a gap in the business owner s retirement plan. Now a new challenge presents itself: How do you transition your hard work and determination into the dream of a secure retirement? For business owners, the task of planning comes with a special set of challenges; it s far more complex than simply retiring from employment with a company. Whether you re planning to gradually shift control of your business or sell it outright, your retirement plans may hinge on how you handle this financial transaction. A quality plan starts with knowing what your ideal retirement is. Take time to think the following items through before you turn the focus to transitioning your business: The date you anticipate beginning retirement. Goals and expectations, such as extensive travel, purchasing a second home, pursuing hobbies, starting another business, or transitioning to part-time employment. Annual expenses the first year you retire and how much those costs are likely to go up in the future, due to inflation. Available income sources to help fund retirement, such as Social Security, a pension, or investments. Whether there s likely to be a gap between your available income sources and what you actually need to meet your expectations and expenses. Retirement savings and proceeds from the sale of your business need to bridge that gap. Failure to plan is planning to fail. Benjamin Franklin We ve all heard that phrase before, and while it may sound harsh, it is so true. Business owners may have spent a lifetime building and running a very successful business. But lack of a strategic plan may lead to the business owner not meeting their goals for retirement. Ed Cowling, Director of Specialty Assets, Asset Management Group, U.S. Bank U.S. BANCORP INVESTMENTS U.S. BANK 2

4 Business Owners Guide to Retirement Planning Real steps to consider Retirement planning is often a complex process, requiring both financial and emotional decisions. Understand both the financial and emotional value of your business. Determine a suitable transition strategy. Identify potential successors, whether family members, internal or external buyers. Help protect against unexpected events that could derail your transition plans. Recognize the risks associated with having your retirement dependent on the sale of your business. Maintain and build on other forms of retirement saving. Navigate possible family dynamics that can complicate business transitions. Strategize around selling the business into a potentially saturated market, as more baby boomers move out of their businesses. Understand an increasingly complex and changing tax code, including state, federal, gift and inheritance taxes. Set up the ongoing management of your succession plan. Choose the appropriate professionals to help you develop and execute your strategy. 3 U.S. BANCORP INVESTMENTS U.S. BANK

5 Determining the value of your business Do you believe that the quality of your retirement will be dependent on a big payoff when the business is sold? If so, you re typical of many business owners who expect to turn the sale of the business into a retirement nest egg. Since owners often invest the bulk of their resources back into the company, they are generally less likely than their employees to have a pension or significant savings in a workplace retirement plan. As a result, it s vital to understand what your business is worth and how it can contribute to your long-term retirement security. Your business valuation needs to include: The value of your business assets. The value to an outside party of the firm s ongoing business (revenue, profits or brand). The value of similar businesses in the marketplace, based on comparable sales figures or how banks are treating loans. An informal valuation can be a great way to start the planning process, but be sure to choose a reputable organization that is willing to work with your advisors. A formal valuation, conducted by a certified business appraiser, may be necessary in order to help secure a loan, settle an estate or finalize the sale of a business. U.S. BANCORP INVESTMENTS U.S. BANK 4

6 Business Owners Guide to Retirement Planning Determining the value of your business (cont.) OPTIONS FOR VALUING YOUR BUSINESS The valuation of your business can help you decide whether you re likely to realize the payoff you need to retire or whether you need to continue to grow your business and its profits. With your advisors, you can decide what valuation method is most appropriate for your business. Some of the options include: Book value: the net value of your business assets, compared with your liabilities. Straight capitalization: average net earnings for the business over a specific number of years, divided by a growth rate that is typically based on the average rate of return for similar businesses. Earnings capitalization: determining a value for the business based on historical earnings and how that might be projected going forward. Years purchased: a conservative rate (a pure money rate for an investment with generally accepted lower risk) is used to determine the earnings attributed to assets. The balance is assumed to be provided by goodwill. The earnings provided by goodwill are then multiplied by the number of years for which goodwill is expected to be valued to a purchaser. The result is then added to the book value to obtain the valuation. Discounted future earnings: using adjusted earnings history as a guide to project a realistic expectation for future earnings that can be assumed in making the calculation. 5 U.S. BANCORP INVESTMENTS U.S. BANK

7 Positioning your company s value in a saturated market The baby boom generation is now reaching retirement age, and an estimated 15 percent or 10 million boomers are small business owners. 1 This creates a challenge: Over a span of years, this huge cohort will be looking to transition out of business ownership and cash in on their investment. As a business owner planning for retirement, it can pay to be aware that: A potential glut of businesses for sale could limit the number of prospective buyers for your business. The Great Recession of heightened the potential for a saturated market because business valuations dropped, causing many business owners to delay retirement and take a wait-and-see approach. Since events beyond your control can have a dramatic impact on your plans for selling your business and funding your retirement, your best defense is to be as strategic as possible. Consider how you will position your business and brand in the marketplace and choose your timing to market with care. Keeping tax consequences on your radar: Typically, proceeds from the sale of your business are considered a capital gain for taxation purposes. You deduct from the sale price any capital investment made to start and grow the business. The difference represents a capital gain, subject to taxes at the federal and possibly the state levels. Keep in mind that U.S. Bank, U.S. Bancorp Investments and their representatives do not provide tax advice. Please consult with a qualified tax professional. Since taxes reduce your net return, this is an important calculation to keep in mind as you weigh your retirement expectations and projected expenses. Also ask yourself: Will the value I receive for my business support my retirement? Are there buyers interested in purchasing my business? If something happens to me, can my surviving spouse or family members secure the value needed to continue on? It may make sense to set up alternative sources of income in retirement, so you re not overly dependent on the successful sale of your business. 1 Source: U.S. Trust, May 27, U.S. BANCORP INVESTMENTS U.S. BANK 6

8 Business Owners Guide to Retirement Planning Depending on the circumstances, following are forms of protection to consider: Overhead expense insurance to help reimburse a business for covered business expenses incurred during an owner or key employee s disability. Life insurance on the business owner and key employees. Buy-sell agreements to help protect succession plans for a business. Sufficient property/ casualty insurance to help cover costs of unexpected physical damage or losses to the business. Striving to protect the future value of the business Given that your retirement security may be heavily dependent on the sale of your business, it makes sense to attempt to protect yourself against unexpected events that could sidetrack your transition plans. Circumstances that impact the value of your business or delay the timing of your sale might include: A disabling injury for the owner or a key employee. The sudden departure (by choice, disability or death) of a vital contributor to the organization. A natural or man-made disaster that causes significant damage to goods and property. Economic disruption resulting from market changes. It s especially important to guard your business against the loss of a key employee, if that person has a big impact on the firm s profitability or is a potential future owner. If you have a succession plan currently in place, consider it Plan A. Then, devise a protection strategy, Plan B, in case something unexpected happens to any potential successor. 7 U.S. BANCORP INVESTMENTS U.S. BANK

9 Diversifying your retirement income It s natural to assume that the bulk of your retirement nest egg will ultimately come from selling your company. However, it s wise to plan for multiple scenarios. Consider this example: Imagine a longtime employee of a large corporation who invests virtually all workplace 401(k) plan dollars in company stock, and then the company stock price is negatively impacted by a severe recession. The employee would have put too many eggs into that one basket, jeopardizing retirement planning. So if you re over-relying on the successful sale of your operation, you could be putting yourself in the same position as that hypothetical employee. By having a good retirement plan in place, you gain more leverage for timing the sale of your business and negotiating the price you want. You and your key personnel should consider diversifying your assets, so your retirement plans remain funded, regardless of how the sale of your business goes. Start by making sure you have a competitive workplace retirement plan. Options include: SEP IRA: This may be the easiest retirement plan for a small business to establish and maintain, with significant flexibility for yearly plan contributions. SIMPLE IRA: This plan also offers the ability to make contributions by deferring salary (pre-tax contributions), without the complexity of other types of plans. Owner-only 401(k): An option for a one person operation, with potentially fewer fees and complexity than a standard 401(k). You can also help build up savings outside of the company, using tools like IRAs, annuities or life insurance, to potentially accumulate wealth for retirement through tax-deferred earnings. This may not be a comprehensive list of workplace retirement plans. Please discuss your unique situation with a financial professional. U.S. BANCORP INVESTMENTS U.S. BANK 8

10 Business Owners Guide to Retirement Planning Most business owners will transition by: Selling to a third party, such as a private equity firm or a competitor. Selling to current employees of the firm. By establishing an Employee Stock Option Program, employees can gain a larger piece of the firm over time. And eventually, as a group, they attain sole ownership. Selling to the existing management of the company. Major players in the organization may be the most qualified, in terms of know-how and financing, to take ownership. Selling and/or gifting the business to children. Remaining with the business in a scaled-back role, while maintaining part ownership. Finding a buyer: Consider your options Many business owners envision cashing in when a buyer comes along who is excited about the future prospects and ready to pay a premium price for the opportunity to take over the reins. The reality is often completely different. The buyer may be someone inside the organization or even the family. There are multiple ways to transition the ownership of a business. You need to work with your tax and legal advisors to determine an approach that s most appropriate for your circumstances. If you decide to sell to a third party, proceeds from the sale could take the form of stock in the acquiring company, cash, or a combination of the two. A business brokerage firm can help bring you together with prospective buyers. If you decide to sell to your current employees or management team, the terms might involve installment payments, with the proceeds flowing back to you over time. If you decide to sell to family members, the transition may be handled as an estate planning strategy, with all or part of the ownership position gifted to children. Children usually aren t in a financial position to purchase the business outright by paying a lump sum for it, so often they assume ownership through a combination of gifting and installment payments. 9 U.S. BANCORP INVESTMENTS U.S. BANK

11 The emotional challenges of leaving your business As the owner of a small business, you may have devoted a significant part of your life to building your enterprise and preparing to capitalize on it, financially. So it stands to reason that you re emotionally, as well as financially, invested in its success. Mentally preparing to let go is an important part of the transition process, and it can be challenging. Here are some things to consider: Would it ease your transition to remain involved in the business, by serving on the board of directors, as a consultant, or working part-time? How will it feel to watch somebody else run what used to be under your own control? Can you be objective and accepting about business decisions that may take your business in a different direction? If your business is staying in the family, do you trust the succeeding generations with the responsibility of keeping it viable? How will you occupy your time after you step away from the business? U.S. BANCORP INVESTMENTS U.S. BANK 10

12 Business Owners Guide to Retirement Planning To keep your business strong and family relationships sturdy: Make sure that family members outline a common vision to share control and income across generations. Take the necessary steps to help family members work side by side and be respectful of changes. Set up strategies to assure that the business generates a sufficient income stream to support participating children, as well as relatives who need a secure retirement income. Help ensure that children who are not active in the business are treated fairly. Some 70 percent of familyowned businesses fail or are sold before the second generation gets a chance to take over. Just 10 percent remain active, privately held companies for the third generation to lead. 1 Family business, family harmony: The delicate balance Challenges lurk when a business transaction involves a family of multiple generations. Retiring members of the older generation need to think about transferring not just the ownership of the business but also its cash flow and management. Planning is the first step when transitioning a family business. But clearly communicating the plan to all family members and key employees is also vital. Your business is most likely to prosper when everyone involved understands their role and why they were chosen for it. Family members who work in the business without ownership rights typically have different questions and concerns than family members who are owners. These may include: Will the owners include me in decisions that are made? How do I feel about current management? Am I currently informed about what is really happening? What can I do to become an owner? Do my parents want me to be an owner or are there reasons they want to hand off control to a sibling? Family members who do have ownership rights may have concerns, including: Are family issues potentially leading to business issues? Are family members who are gaining control competent to run the business? 1 Source: George Stalk and Henry Foley Harvard Business Review Jan Feb U.S. BANCORP INVESTMENTS U.S. BANK

13 Retirement for farm and ranch owners Family farms account for 98 percent of all farms in the United States, and 86 percent of its total agricultural output. It is estimated that 70 percent of all U.S. farmland will change hands in the next 20 years. 2 The future of U.S. agriculture depends on the ability of new generations to establish successful farms and ranches. A major challenge for these successors is the ability to afford and secure farm or ranch land. What was once a simple generational hand off is now more complicated because of the significant increase in land value. The next generation likely cannot afford to buy expensive land. At the same time, farm and ranch operations have become more capital intensive the need for labor has been reduced, but the cost of sophisticated equipment has sky-rocketed. All of this can weigh heavily on the mind of a farmer or rancher who is considering when and how to retire. Like other entrepreneurs, farm and ranch owners are often attached to their businesses. The difference lies in the fact that you may be looking to your land and equipment to fund retirement. While selling land may create the needed income, it can complicate transferring the farm or ranch to the next generation. These choices become more emotionally difficult when the land has been in the family for a long time. The retirement process can be complex and time-consuming for farmers and ranchers, so it s reasonable to put a plan in place as many as 10 years before the actual transition happens. Specialty Asset Management, Farm and Ranch group U.S. Bank s Specialty Asset Management, Farm and Ranch group, works with families, individuals and ownership entities through the transition process of retirement. We offer proactive management and specialized resources for all farm and ranch assets, while helping you work toward both short- and long-term financial goals. Each farm or ranch situation is unique, and we strive to meet the requirements of your particular ownership situation. Our group s goal is to provide management services, resources and technology that maximize the value of your unique farm or ranch operation while protecting the quality of your land. 2 Source: CSREES, United States Department of Agriculture, U.S. BANCORP INVESTMENTS U.S. BANK 12

14 Business Owners Guide to Retirement Planning Start planning now It s essential to review the value of the business at least every couple of years, along with monitoring fast-changing tax laws. To potentially maximize the value you receive from your business, it s essential to start planning early, even a full decade before you intend to sell. This may allow you to build and execute a transition strategy that leads to the kind of retirement you really want. Consider these steps: Clarify your retirement plan and financial expectations for the sale of the business. Set a realistic time frame for when you ll be financially and emotionally prepared to begin transitioning or sell the operation. Define the value of the business through a formal or informal business valuation. Determine ways to maintain or improve on that valuation to help meet your financial goals at the actual point of sale. Assess the market for potential buyers to determine a successful transition strategy. The steps you take to prepare for the sale might vary, depending on whether the buyer is a third party, current employees or family members. Identify your protection needs and purchase appropriate and sufficient insurance coverage to help prepare for any unexpected events that could derail your transition plans. Be prepared for the tax impact of the sale. Be sure to understand what the net proceeds will be prior to signing any sales agreement. Overall, maintain a flexible approach to succession and retirement planning. Once you ve executed your plan, be sure to follow up to help make sure the value of the business can meet the financial expectations you set up. 13 U.S. BANCORP INVESTMENTS U.S. BANK

15 Making retirement a reality: The strategic resources of U.S. Bank Your U.S. Bank professional has the expertise to help you navigate the challenges of your unique business transition. SMALL BUSINESS SOLUTIONS U.S. Bank is committed to your ongoing business and retirement needs, offering a full array of banking services that can help you manage your cash flow and future growth opportunities including: deposit and savings solutions, business credit and financing, and streamlined customer and vendor payment options. To learn about all of U.S. Bank s small business solutions, visit usbank.com/smallbusiness. Work one-on-one with a dedicated Financial Advisor. For assistance with retirement planning, contact your U.S. Bancorp Investments Financial Advisor. If you don t currently have a Financial Advisor, talk to your U.S. Bank Relationship Manager or visit investments-wealthmanagement to find an advisor in your area. SPECIALTY ASSET MANAGEMENT GROUP U.S. Bank s Specialty Asset Management group is dedicated to the unique needs of specialized investments. We actively manage farms, ranches, real estate and minerals for clients, while also providing oversight for business and non-publicly traded companies. By working in tandem with others on your team, such as insurance, accounting and legal professionals, we structure solutions that give your retirement plans the greatest opportunity for success. U.S. BANK CONNECT U.S. Bank s commitment to business owners extends beyond banking solutions. U.S. Bank Connect offers tools, advice and networking opportunities for every stage of your business life cycle. Visit usbankconnect.com today. You know what it takes to build a prosperous enterprise. Now take the necessary steps to move closer to your retirement goals. U.S. BANCORP INVESTMENTS U.S. BANK 14

16 RealSteps>Retirement is a comprehensive retirement planning process designed to help our clients navigate the complexities of retirement. Through our RealSteps approach, we seek to bring clarity and confidence to retirement planning, helping you move closer to your goals step-by-step. Real Understanding Your plan starts with gathering information, identifying goals and concerns, and uncovering gaps and challenges. Real Answers TM Together we build a comprehensive financial plan for you, based on strategies around helping to generate cash flow, striving to grow and protect assets, and establish a legacy. Real Progress Once your plan is in place, we continue to work with you, maintaining its dynamism to help keep pace with life s changes. USBI-LIT (01/16)