Through our discussions with owners of closely-held companies, we’ve noticed that one topic seems to be coming up more often lately. Owners are telling us that business is pretty good right now and they’d like to take some money off the table, and they’re inquiring about their options to get more liquidity.
I think the main driver for this conversation is that more owners are starting to focus on retirement. And as part of that process, they are contemplating how much in liquid assets they will need to retire with the same or an even better lifestyle than they enjoy now.
It’s good that they’re thinking ahead, because advance planning is crucial. For example, to have a lifetime income of $20,000 per month, many financial planners estimate that you would need at least 25 times your annual needs (i.e., a total of $6,000,000) in liquid assets. Otherwise, there is a real risk of running out of money during your lifetime.
Those numbers come as a surprise to many owners, and they then ask us what their options are to increase their liquidity. Below are four possibilities:
- Take out more salary (especially if income tax rates decrease at some point). Since many of the businesses that our clients operate have more discretionary income, this is often a viable option from the company’s standpoint. However, most owners would prefer to defer the tax on these profits, if possible, until income tax rates decrease. We concur with this line of thinking.
- Borrow money and make a distribution to the owners. This is a viable option, but owners are often hesitant to borrow more money in a rising interest rate environment. They may also incur an income tax on the distribution if they don’t have sufficient basis in the company (a tax topic that no one likes to discuss). Most owners aren’t enthusiastic about borrowing more money, especially if they are a guarantor on the loan already.
- Sell a portion of the company, either to an employee stock ownership plan (ESOP), key management, the next generation, or a third party. More owners appear to be leaning in this direction after they have had time to think through all of the options. Narrowing down the list of to whom they could sell seems to be the more difficult decision.
- Sell all of the company to the next generation, key management, or a third party. Most owners still want to have some involvement in the company and are not ready to walk away but, for those who are ready, this can be a real option.
If this is a topic you’ve been thinking about, we would recommend that you start discussing your available options with your advisors, family, and tax preparer. They can help you define your goals and plan the right strategy for you and your business.
David E. Shaffer
is a director with Kreischer Miller and a specialist for the Center for Private Company Excellence. Contact him at Email.
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