Financial service professionals looking to improve their business would do well to look to the small business owner marketplace.

For many years, the general description of a small business was a firm with less than 500 employees. However, an Internal Revenue Service definition first surfaced with the effective launch of Simple IRA plans in 1998. Since then, the same definition appeared again in the Economic Growth Tax Relief Reconciliation Act of 2001 with the determination of eligible employees for plan start-up credits for small businesses. According to the IRS definition, a small business was an employer that had 100 or fewer employees who received at least $5,000 of compensation from the employer for the preceding year.

Regardless of what terms are actually used to define small business, financial advisors should remember that defining the small business owner goes beyond any generally accepted description or IRS calculation. The small business owner is not only concerned with the profitable operation of the business; he/she must be concerned with the personal concerns of their employees and their happiness in working for the business. There is quite a bit of truth to the expression that “a happy employee is a good employee” and good employees are essential to the profitable operation of the business.

Most importantly, the financial advisor must remember that the owner of the business may also be an employee of the business and therefore subject to concerns of happiness that every other employee has. After all, when the owner leaves work for the day, the owner  takes on the concerns of a husband or wife, father or mother, son or daughter or brother or sister. The owner also is a member of the community and may have inclinations to serve the community in volunteer or charitable capacities. Therefore, when a financial advisor is considering working in the small business marketplace, the owner is actually getting a two-for-one audience; the owner of the small business and the family person.

In my many conversations with small business owners, I have found that there are three frequent mistakes that a small business owner makes when it comes time to take care of family concerns. They are: (1) Retirement Planning, (2) Proper Insurance Protection and (3) Conversion of Business Wealth to Personal Wealth.

Mistake 1: “My business is my retirement.”

Many business owners look to building their businesses not only for the immediate financial benefits, but for the potential value that the sale of the business will bring to their retirement planning. This is a good piece to the retirement planning process, but it should never be the only or major piece to the process.

The sale of anything has to deal with two quantities: the value and the price.

Value is a consideration that is solely in the eyes of the beholder. How the seller determines value is not necessarily how the buyer perceives value. Considerations such as inventory levels, product or concept exclusivities, patents, client lists, relationships, competition, sales and marketing methodology, and growth potential are a few of the concerns that impact a calculation of value. Price, is the final dollar amount agreed upon after the value discussions are completed.

The small business owner that is using the sale of the business as the cornerstone of their retirement plan must be able to answer the following questions. Will my business be “sellable” when I’m ready to retire? Will I have willing and financially capable buyers? Will I be able to negotiate a sales price that will be in line with my perceived value?

The small business owner should consider the following to help answer these questions. First, obtain independent business evaluations that determine “value” from a market perspective, not from the perspective of the owner. These evaluations should be done every couple of years or when considerable changes to the business plan, model or competition takes place. Second, take precautions to protect the happiness of the workforce. Make sure the employees are willing to stay on after the sale. Finally, keep the personal and business ends of the transaction in the proper perspective. Don’t let emotion cloud the structuring of a “good deal”.

Mistake 2: “I’m good with my insurance products and amounts.”

Many times, the small business owner takes a “set it and forget it” approach to insurance coverage. This is very dangerous. Changes to the size of the business, obligations of the business, customer lists, business model, business structure or methodology all have impacts on business evaluation and therefore on having the proper types and levels of insurance coverage. As the business remains fluid, so should the insurance coverage.

When partners are involved, serious consideration should be given to a buy/sell agreement, with a structured valuation and funding vehicle. Bottom line: You do business with your partner, but can you do business with your partner’s heirs?  If the answer is “no” or “I’m not sure,” then there should be a fair and equitable mechanism to transfer the business interests from the deceased Partner’s heirs to the surviving partner(s). A current buy/sell agreement should do the trick.

The business should also be protected from the loss of a key individual. Consideration should be given to insuring the position, the individual or both. For example, the office of the chief accounting officer needs to be filled to keep this function of the business in good order. Personalities aside, an individual with strong accounting skills could fill this position with limited impact on the operation of the business. On the other hand, the loss of a key sales representative with deep customer relationships could have a major impact on the operations of the business. Replacing this individual may take a long time and may cost the business additional money to attract someone with similar relationships.

Death is not the only reason for the loss of an individual to the business. Short term and long term disability could have dramatic impacts on a business for much the same reasons as above and considerations should be given to having the proper types of disability coverage.

The need for the correct types and amounts of property and casualty coverage also change more frequently than the small business owner realizes. Although there are minimum requirements set forth by federal and state governments, franchisors and creditors, the business owner must consider the actual amounts that are needed to keep the business viable in a worst case scenario. Natural disasters, accidents and lawsuits can paralyze or eradicate a business without warning. Making sure that the various types of P&C coverage are current and up to date should be an ongoing concern.

Mistake 3: “I plow all my profits back into the business.”

Many business owners feel that it is very important to keep their personal assets completely separated from their business assets, and in fact, strive to have the business purchase a good deal of assets to reduce personal taxes. Although there is a strong rationalization to this way of thinking, there comes a time when the business owner should give serious consideration to converting business wealth into personal wealth.

Earlier we discussed how the value of a business could change over time. It may go up, or it may go down. Sometimes it is the business owner’s fault and sometimes it is due to outside circumstances. Regardless of the situation, the business owner who plows everything back into the business will see his or her business wealth, and not surprisingly personal wealth, rise or fall accordingly. The business owner who uses the business to create Personal Wealth is not as dramatically tethered to the fluctuations of business wealth.

Take, for example, the business owner who takes profits out of the business and makes personal investments in real estate and a diversified portfolio of stocks and bonds. The value of the properties and the investment portfolio will vary based on the fluctuations in their respective markets, not based on whether or not the business had a good sales month. In addition, the business owner may find agreeable financing opportunities based on assets held away from the business, and this may provide needed capital for improvements to and for the business.

It is very important for the financial advisor to remember that the concerns of the small business owner are directly intertwined with the concerns of the individual. The personal objectives of the individual are made possible by the financial success of the business, and the financial success of the business is driven by the personal objectives of the owner. Knowing and understanding the needs, objectives, resources and capabilities of both is the foundation of a lasting relationship between the financial advisor and the small business owner.

About the Author

Bill Zimmerman is a retirement solutions consultant with with The Hartford Financial Service Group.