Preparing for Transition: Personal Financial Planning

Monday, February 27, 2012 01:13
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Preparing for Transition: Personal Financial Planning

Tags: business planning | enterprise value | exit planning | financial planning | retirement income | retirement planning

When looking to transfer power and ownership to second or third generations, the business owner must determine if the business will financially support this strategy. In other words, can the business support the current owner(s) as well as the second (and/or third) generation?

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EXAMPLE

Joe owns a successful distributorship company. His son, Eric, works in the business and is qualified to take over the company. Joe and Eric earn annual salaries of $200,000 and $75,000, respectively. After salaries, the business produces an annual profit of $150,000. Joe would receive $1 million were he to sell the business. When Joe retires, Eric wants an annual salary of $125,000 and he will need to hire an additional employee at an annual salary of $75,000. Joe would like to receive consulting income of $50,000 per year and also wants to sell the business to Eric on a five-year note. Without considering taxes, and assuming annual note payments of $250,000 per year (including interest), the company's cash flow after Joe's retirement would be:

Pre-retirement net income:

$150,000

Plus: Joe's salary

  200,000

Less: Eric's salary increase

 (50,000)

Less: New employee's salary

 (75,000)

Less: Joe's consulting fees 

 (50,000)

Less: Note payments

(250,000)

Post-retirement cash flow

($75,000)

Thus, based on the company's current level of profitability, the business will not support both Joe's and Eric's financial needs. To ensure the financial viability of the company, Joe may need to extend his note out over several more years. Unfortunately, this may not meet Joe's monetary requirements.

There is no easy solution when the company cannot support the financial needs of the retiring owner as well as the successor(s). Alternatives to be analyzed and considered include:

  • Extending payment terms;
  • Setting a contingent sales price;
  • Reducing the sales price;
  • Reducing or relinquishing consulting payments;
  • Obtaining outside investors;
  • Structuring the transaction differently, such as utilizing an ESOP or selling only a partial interest; and
  • Delaying the transaction.

 It is clearly important that personal financial planning be part of business transition planning!

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