Retire Without Selling Out: The Role of Exit Planning in Securing Your Lifestyle

For many owners of lower middle market businesses, the culmination of years of hard work and dedication brings them to a pivotal stage in their careers. Having built a thriving business and nurtured a comfortable lifestyle, owners often find themselves at a crossroads: stepping back from day-to-day operations while ensuring the continuity and prosperity of the business they’ve poured their lives into. A well-thought-out and executed Exit Plan can provide the framework for achieving these goals.

Situation Overview
Business owners in the later stages of their careers may prefer to pass their business to the next generation or to the internal management team rather than sell to a third party. After years of grooming successors and developing staff, they may be ready to transition out of the daily grind. However, their financial circumstances can complicate this process. Many owners find that their net worth is heavily tied to their business, leaving limited personal savings or investments to support their desired retirement lifestyle.

According to surveys by the Exit Planning Institute (EPI), on average, 80% of business owners’ net worth is tied to their businesses. For non-business owners, net worth is typically more diversified, with 52% in non-financial assets (like real estate) and 48% in financial assets (like stocks).

The Wealth Gap Challenge
This reliance on the business for personal wealth creates what is often referred to as the “Wealth Gap.” This gap represents the shortfall between the wealth goal (the amount needed to sustain a desired retirement lifestyle) and the owner’s current retirement savings or non-business net worth.

How to Determine the Wealth Gap

• Set a Wealth Goal: Identify the financial resources required to maintain your desired retirement lifestyle. This step often involves consultation with a wealth/financial advisor.
• Apply the 4% Rule: A general guideline for retirement planning, the 4% rule suggests that retirees can withdraw 4% of their savings in the first year of retirement and adjust that amount annually for inflation for 30 years. For example, if an owner needs $200,000 annually, they would require approximately $5 million in savings ($200,000 / 4%).
• Monte Carlo Analysis: A wealth advisor can perform a detailed probability analysis to project a range of retirement outcomes tailored to the owner’s circumstances.

Without sufficient retirement savings outside the business, owners may face two primary challenges:

1. Need to sell the business to fund retirement.
2. Continuing to draw an above-market salary, potentially creating tension with active partners or family members managing the business.

Some Solutions to Bridge the Wealth Gap
Effective Exit Planning must go hand-in-hand with Succession Planning. While succession focuses on leadership transition, Exit Planning ensures financial security for the outgoing owner. Below are strategies to fund retirement without jeopardizing the business’s future:

1. Recapitalization
Restructuring the company’s capital structure can provide owner liquidity while maintaining control within the family or management team.

One option may be to issue new common shares to management and/or next generation owners at little to no value and convert common shares to preferred shares at the businesses existing enterprise value. The preferred shares can be redeemed over time, allowing the owner to receive periodic payouts to help fund their retirement.

Another option may be to refinancing the business and take on debt (senior or junior) to fund dividends for the retiring owner.

2. Minority Recap with Private Equity or Family Offices
A partial sale to a private equity group (PEG) or family office can provide liquidity while retaining majority ownership. This approach can inject capital into the business to provide some liquidity and reduce the owner’s financial reliance on drawing a full time salary.

3. Earnout Structures
An earnout arrangement allows the owner to sell the business gradually based on the cash flow provided by the business, either through a management buyout (MBO) or by transferring ownership to family members over time. This phased approach can help ensure a smoother transition as long as there is sustained cash flow for the retiring owner.

4. Employee Stock Ownership Plan (ESOP)
An ESOP allows employees to acquire ownership in the business over time, providing the owner with liquidity while fostering employee engagement and continuity.

Final Thoughts
A successful transition from business owner to retiree requires a strategic approach that addresses both leadership succession and financial security. By incorporating Exit Planning into Succession Planning, owners can:

1. Secure their retirement lifestyle without selling outright to an external party.
2. Preserve family or management’s ability to lead and grow the business.
3. Avoid potential resentment or financial strain on active stakeholders.

Engaging experienced advisors - including wealth planners, financial analysts, tax and legal experts - is crucial to crafting a plan that achieves both personal and professional goals. By bridging the wealth gap and executing a thoughtful Succession AND Exit Plan, owners can enjoy the best of both worlds: financial independence and a lasting connection to the business they’ve built.

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