Steve Davis, CEO — Total Wealth Academy.
Developing an exit strategy is an important task for business owners, especially as they near retirement. It is also usually a neglected task, as the day-to-day duties that the business requires distract owners from planning for the future.
Then, one day, business owners wake up and realize they are quickly approaching 65 and need to do something about their financial security. At that point, they will often sell their business for a large sum of money and dive into retirement, praying that the money won’t run out before they die. But selling their business means they are also losing their paycheck.
Those looking for a better plan should consider establishing a second stream of income. This will allow you to keep your paycheck, so you won’t need to worry about the money running out. If you’re under the presumption that earning a paycheck and being retired don’t go together, then you need to understand the difference between active and passive income.
Moving From Active To Passive Income
Most business owners would not consider themselves to be self-employed, but sole proprietors, independent contractors and freelancers—all of whom can also be business owners—are classified as “self-employed” on their tax documents. People usually consider themselves business owners once they begin hiring others to work for them.
I have a different take on the difference between being self-employed and being a business owner. You can consider yourself a business owner only if you can disappear for a year and still make the same amount of money as you would if you were there. If you can’t do that, you are self-employed.
The business owner has a passive income—they do not need to actively participate in the business to earn it. The self-employed person has an active income—they need to show up every day and generate leads for the business, sign off on product designs or handle customer complaints. In essence, if they aren’t at the office, the business suffers.
When it comes to establishing a second stream of income, passive income is often the goal. You can begin the journey as an active investor, for instance, but you can later transition to being a business owner with a passive income.
Buying an apartment complex and running it is an example of active investing. If you are handling the day-to-day problems and challenges, you are self-employed. But when you give your money to a real estate investor who returns your investment with interest—leaving you with nothing to do but deposit your checks—you are a business owner with a passive income.
Leveraging Succession Planning To Become A Business Owner
Succession planning is one simple way to create a passive stream of income. By hiring someone to step into your role after you retire, you transition from being self-employed to being a business owner, creating a passive stream of income in the process.
To understand how this works, picture someone who is self-employed and making $1 million a year from his or her company. That person can hire two people to manage the company, pay them each $150,000 a year, become a true business owner, and still make over $50,000 each month (excluding other expenses).
To truly benefit from succession planning, however, consider leveraging it long before you hit retirement age. Succession planning should begin as soon as a business becomes profitable. Using succession to transition from being self-employed to being a business owner frees you up to retire early or launch a new business.
Accepting That No Paycheck Is Guaranteed
The widespread layoffs occurring over the past 18 months have made it clear to employees that no paycheck is guaranteed. Those who run businesses need to accept the same truth.
The last few years have been hard on business owners. In the U.K., business insolvencies increased by 57% from 2021 to 2022.
Long-term statistics from the Bureau of Labor Statistics (via Investopedia) show that only 25% of new businesses survive 15 years or more. If you are paying attention to the numbers you know that, even when you own a great business, there are benefits to succession planning and developing a second stream of income.
The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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