Why should I not rely on my business to fund my retirement?

If you run a successful and lucrative small business, it is easy to think you will either continue to run it forever or sell it for a tidy sum when you want to retire.

Many small business owners pour a lot of what they earn back into their businesses to build its profitability and earning potential, but fail to invest in anything else.

It’s easy to view the business as a nest egg for your old age but converting it into an income stream in retirement may not be as simple as you think.

Failing to plan for retirement is also a mistake, as you do not know how you will feel about continuing to run a business when you are older and potentially have health issues. Running a business without giving it your full energy may also lead to the business losing its edge.
 

Converting your small business into retirement income

Small business owners often think they can solve the problem of providing an income in retirement by selling the business and investing the proceeds or handing it over to a family member who will pay you an income from the business.

It is a good idea to consider the following:

• What your financial needs will be in retirement;
  
  
• How much your business will be worth at retirement;
  
  
• Whether the business will realise enough to sustain you for the rest of your life;
  
  
• Whether the business can afford to pay a family members enough of an income and pay you as a shareholder should a family member take over the running of the business.
   

Problems selling the business

The problem with planning your retirement around the sale of your business, is that you can’t be certain what it will sell for or that it will sell.

According to research conducted by the American Exit Planning Institute, only 20% to 30% of all small businesses that are listed for sale are sold. Similar statistics aren’t available in South Africa, but it’s a big gamble to take.

Some of the reasons why it is difficult to sell a small business include:

• Small businesses often rely heavily on the owner’s expertise and contacts to be successful, so if the owner sells or retires, the value of the business without that key person will be lower;
  
  
• You may become ill or disabled before retirement age, resulting in the business losing your expertise and relationships with clients. This may impact the value of the business. Ideally, you should protect yourself against illness or disability throughout your working life and protect the business from losing any key people, including yourself. If you have partners, you can enter into a buy-and-sell agreement and back it with life cover to ensure that you or your heirs can realise your share of the value of the business should you be disabled or die.
  
  
• You’re emotionally invested in your business, so it’s easy to overestimate the value. Asking too high a price for the business can result in you battling to sell it, leading to disappointment and frustration when you realise that your estimates were too ambitious. Getting your business professionally valued annually can help you track your business’s growth and determine what you need to do to increase its value.
  
  

Succession planning problems

If you expect a family member to take over the business and pay you a retirement income, you need to do succession planning and have an exit strategy in place.

According to PWC’s Africa’s Family Business Survey in 2021, 76% of African family-owned businesses don’t have a succession plan in place, so it’s important to address these issues with your family:

• Do they want to continue or take over the business?
  
  
• Who will manage the business?
  
  
• Can the business afford to pay you a fixed monthly income while providing a sustainable income to the new owners?
  
  

The value of bricks and mortar

How you are invested in your business can impact your retirement significantly. If you own the physical premises, you can sell it when you retire, even if you can’t sell the business as a going concern.

The risk of relying on selling the physical premises is that you don’t know what the property market will be like when you retire.

It is important to remember that areas change over time and this could significantly reduce or enhance the value of the property you own.

The property may seem like a valuable asset but you have little or no diversification – your retirement depends on one or a few business premises. If things don’t go according to plan, your income in your old age will be compromised.

Alternatively, you could sell the business but not the premises and collect rent from the new owners.

You will become a landlord, which introduces new issues, including the risk of your tenant failing to pay rent. It isn’t easy to manage tenants, so you may want to consider appointing a managing agent to take care of this for you for a fee.

Safeguard your future

As a small business owner you should plan for your retirement while you are building your business.

Start by understanding what your financial needs in retirement will be and setting your retirement investment goal. A financial adviser will be able to guide and advise you on your needs and goals.

Then choose appropriate investments which will provide diversification of assets and returns as you build up to that goal.

Commit to saving a certain amount each month and stick to it. If you have a good year and have extra cash, inject a lump sum into your retirement savings to bolster your nest egg.

If you use a retirement annuity to save for your retirement, your investment in it is protected from creditors, making your savings safe no matter what happens to your business.

Your business can be an asset in your retirement plan, but it should not be the only one and you should take care estimating its value at retirement.

Tax issues

There are tax advantages to investing for your retirement in a retirement fund instead of only investing in your business.

Contributions to a retirement annuity fund are tax-deductible within certain limits, the growth in the fund is tax free and you may be able to take some capital tax free at retirement if you have preserved your savings.

If you sell your business at retirement, on the other hand, it is likely to attract capital gains tax.