Workplace

As a business owner, you eventually will face the task of monetizing the equity trapped in your privately held business, which likely is your largest asset. This is made more complicated by current economic conditions, which are causing individual retirement accounts to decrease dramatically and home values to depreciate.

Examining how your company's value can be extracted is an integral part of the exit planning process and something to consider as you move toward retirement.

Extracting value

There are two ways to extract value from your business. First, you draw income directly from the business in terms of salary, personal and business expenses, bonuses you pay yourself and retirement plan savings. A second and much more important income route—particularly in light of current economic conditions—is retaining the equity, or nonliquid part, of your business (in other words, monetizing the wealth trapped in your business).

Essentially, the equity in your business represents more than the business's accumulated earnings; it represents the value someone would pay for it. Business owners naturally are inclined to want to sell their businesses and pull out all the equity at once. But the current marketplace has fewer buyers and consolidators than in previous years.

Before deciding what course of action to take, you first should determine your "value gap," or how much money you need to extract from your business to maintain your lifestyle after you retire.

For example, assume you have $1 million saved for retirement and need about $5.5 million to maintain your lifestyle; your value gap would be $4.5 million. Based on this scenario, if you were to sell your business, you would need an asking price of more than $4.5 million because you would owe federal and state taxes and advisory fees. And like many business owners, you probably would be challenged by the market's current lack of buyers and lower values. In this instance, you would want to consider alternative ways of accessing the equity in your business.

Alternative options

One option to consider is selling a portion of your business's equity to an employee stock ownership plan (ESOP). By selling part of your company's equity, you could bolster your current savings (increasing your financial readiness) while continuing to work and own a majority of the stock in your company.

Although you likely would get a lower value for the shares sold, you could begin to diversify yourself from the business. You also could receive important tax benefits that accompany an ESOP sale that could bring your net proceeds closer to what you would make in a sale to an outside buyer. This is a structured way of accessing the equity in your business while maintaining financial and strategic control, as well as continued income and benefits.

You also could consider having your management team assist you with extracting your business's equity. Your management team has the potential to continue running the business in your absence.

However, you would be wise not to immediately discuss this possibility with your management team. You might wait four years to sell your company, and you do not want to promise your management team a future ownership stake that you may be unable to deliver. When measured against what you need to extract from your business, it may turn out having your management team pay you out over time is the best option—and you could build a stronger company in the meantime.

Achieve your goals

Regardless of how you access the equity in your business, it is important to have a concept of your business's value beyond the profits directly channeled to you. Then, you can begin to think of your business as an investment and start creating your exit plan to monetize trapped equity and achieve your personal goals.

Kevin J. Kennedy is president of Beacon Exit Planning, Elmira, N.Y.