By Bob O’Hara
July 15, 2010
Say the words “exit planning” to most business owners and the typical first response will likely focus on who they hope to sell the business to, when and of course, for how much. But what is often not factored into the equation is the gap between a company’s value today and the amount needed for the owner to enjoy financial security when that future sale is realized.
Quantifying the amount needed to leave a company and realize a financially comfortable lifestyle comes down to a basic formula, so long as you’re working with realistic numbers.
For example, if you’re a small business owner preparing to sell your company in five years, your exit planning should include a determination of what the value of the business must be in order to effect a lucrative transition to retirement – in other words, quantifying resources.
But the formula doesn’t end there. To ascertain a genuine gap-closing figure, you must come up with a realistic assumption for a rate of return on investments, a projected rate of inflation, an estimated life expectancy for yourself and spouse, value all of your non-business assets and the all-important desired annual living expenses post sale or succession.
To illustrate the importance of determining an annual living expense figure, let’s put some numbers on the table. Say that a business owner concludes he will need $4 million on the day he sells his business to generate the income needed to fund his living expenses. He projects $500,000 of available non-business assets and an estimated net proceed of $1.5 million after taxes based upon the current fair market value of the business.
What it boils down to is this owner has a gap of $2 million that has to be made up – this can be achieved through building the company’s value and/or by increasing his non-business savings rate between now and the projected time of sale. Typically, a combination of these two efforts will result in the business owner achieving his financial goals.
This is an example of why it is vital to quantify all resources – both business and non-business – well in advance of exiting. The more time an owner has to work on building business value and saving for his retirement, the better.
Ultimately, you need to ask yourself three questions:
• What is the annual after tax income I need to fund my lifestyle after business ownership?
• Will I be financially independent if I were to sell the business?
• Am I already financially independent of my company?
It comes down to knowing today – to your best ability – how much you need to save, in addition to realizing the value from your business, in order to have enough assets to generate the income needed to fund your lifestyle when you no longer own the business.
“Numbers don’t lie” is a truism for good reason. By establishing your gap-closing figure you will have constructed a foundation for all future value building options in addition to motivating yourself to begin the preparations necessary to implement a successful exit plan.
Bob O’Hara, CPA/PFS/MST/,CExP is President/CEO of O’Hara & Company, founded in 1995 to address the growing need for entrepreneurs to create a comprehensive exit strategy for their businesses. O’Hara & Company hosts an educational website for business owners at www.exitplanning-edu.com.