The business of preparing for retirement

It is critical for the financial services industry to work with business owners to help them prepare for comfortable retirement. Sam Rubin examines different strategies planners could use to demonstrate value to potential SME clients.

There are 1.26 million small to medium businesses in Australia. Approximately 40 per cent of their owners are over the age of 50, and up to 40 per cent have no formal business plan. Small to medium enterprise (SME) owners have their homes on the line, which equates to an estimated $1.6 trillion.

The financial services industry can play a vital role in supporting and protecting the financial wellbeing of this segment via quality business and financial planning advice.

One of the main issues facing many SME owners is the fact that their retirement capital may be based on over inflated expected business sale prices. Another issue is the uncertainty over who will purchase their business. As average SME owners are in their 50s, we would expect over the next decade an oversupply of SMEs for sale, which may reduce business sale prices based on supply/demand economic theory.

Financial planners are in a great position to assist business owners in preparing their business for sale, as they themselves may be small business owners and could be facing similar issues. By expanding their service offering, planners will have access to a new revenue stream for their existing client base.

Planners can also partner with other financial services professionals to focus on servicing the SME market. Providing business services to this market has been proven to be financially and personally rewarding.

True business value

It is vital for financial planners to understand the true business value through an independent valuation. If planners don’t understand the true value of their client’s business, it is like trying to provide someone with a pre-retirement plan without any information on their superannuation account, such as balance, contributions, earnings and portfolio. It would be impossible to complete a full statement of advice.  

An independent valuation will provide the business owner a true indication of what their retirement capital may be upon sale. It will also assist in understanding the qualitative and quantitative business fundamentals in the matters that may have an impact on the business value.

One business valuation method widely used in the market is the market capitalisation method. This method is based on the following equation: business valuation = adjusted EBIT x capitalisation factor.

Adjusted EBIT (earnings before interest and tax)

EBIT is adjusted to normalise expenses and revenue items that are stripped out by the owner. For example, when the business premises are owned by the business and no rental costs are incorporated into the financial statements, or when owner’s salaries are below market rates.

Capitalisation factor 

This is a multiple that is used to determine the goodwill value of the business. This includes qualitative and quantitative measures, such as business IT systems, reliance on business owner, security of premises (especially for a retail business), KPI process for employees (eg, is there a system in place to make employees work towards improving business profitability). Financial planners need to work with owners to understand these fundamentals and their relationship with the valuation. These could include some of the following:

• IT business systems. 
• Reliance of the business owner.
• Lack of staff support.
• Debtors turnover ratio.
• High level of staff turnover.

Planners could work with the business owners and implement the following strategies:

• Implement new/upgraded IT business systems to maximise reporting capabilities and business efficiencies.
• Help transition the business owner to the back office while implementing an employee incentive program to empower staff to support/service customers.
• Create an employee incentive program with key performance measures and indicators; this should include regular employee reviews and training.
• Implement a discount incentive to pay bills on time (such as a five per cent discount) and review all debtors and whether they are appropriate.

Financial planners have the opportunity to incorporate business services as part of their value proposition to their SME clients, supporting long term business growth for themselves and their clients. In marketing to SME clients, planners could also focus on SME financial planning strategies, which would help build their business as a specialist in this market.

SME financial planning strategy opportunities

Some of the financial planning strategies available to SME clients could cover maximising social security benefits, diversifying assets and utilising superannuation.

Social security

As part of the social security work bonus scheme, individuals over the pension age and still working will have their first $250 of the fortnightly employment income exempt from the incomes test. From 1 July 2011, an employment income concession bank has been introduced to enable pensioners to accrue any unused amounts of the $250 fortnightly exemption (to a maximum of $6,500).

Where you have an SME client operating their business as a sole trader and they are at, or over, the pension age, one strategy could be to discuss incorporating the business to maximise their social security age pension.

Example – Lauren 

Lauren is 65 years old and runs a small catering business. She operates as a sole trader and last year had a net profit of $30,000 from the business. Apart from her home, Lauren owns minimal assets and has approached her financial adviser to ask about her age pension entitlements.

Lauren’s financial adviser suggests that she consider operating under a company structure and receiving a salary of $30,000 to increase her age pension entitlements. Please refer to Figure 1.

Extra pension received is $125 per fortnight or $3,250 per annum.

Diversifying assets - superannuation

Generally, incorporated business structures pay owners a salary up to $80,000 to cap the tax at 30 per cent. Financial planners can assist owners by suggesting retirement and taxation strategies.

Where the business cash flow can afford to, advice can be centred on utilising the individual owner’s superannuation caps. This would help reduce their retirement risk by diversifying assets away from full reliance on business assets for retirement, at the same time reducing taxation to a 15 per cent tax rate.

Financial planners have an opportunity to provide quality business advice, coaching services and tailored financial planning solutions by truly adding value (which they can control) by maximising business valuations and overall retirement capital for clients.

For many planners thinking about how the new Future of Financial Advice world will affect their own SME business, incorporating these services into their value propositions can support growth in both their business and their clients’ businesses.

Sam Rubin is head of technical services at IOOF.