FINANCE: Quantify Your Resources: The Ultimate Exit Test
Column by Tad Lyle
In the first step of The Seven Step Exit Planning Process, you, as an owner, establish three primary exit objectives:
- The date you wish to exit.
- The amount of cash you want upon exit.
- Your choice of successor.
Last month, we established the importance of a professional valuation of your company. However, we did not touch on the resources you may have outside the business. Today, let's look in more detail at that second objective: How much cash will you need from the sale of the company to enjoy a financially secure post-business life? For most owners, this is a great starting point for determining when, or if, they can leave their businesses.
Ron Nee, the fictional owner of the landscaping company, engaged his financial adviser to:
- Set a realistic assumption for a rate of return on Ron's personal investments;
- Research actuarial information to determine average life expectancies for both Ron and his wife; and
- Help him and his wife agree on and establish an acceptable post-exit annual income amount.
As part of this process, Ron and his advisor reached the critical question whose answer would determine Ron's ability to retire on his terms: What must the value of Ron's business be if Ron is to leave, as he desires, at age 63?
Like Ron, your resources are likely both in the business and outside of it. You need to know the value of both so you can determine if there is a gap between the amount of money you will need in the future and the amount you have today. This gap must be quantified and-to exit successfully -- you must create and implement a plan to close that gap. Most owners retain an experienced financial planner to help with this project.
Ron and his advisor used the following process:
- Ron and his wife (Pam) agreed on their future annual income needs. They believed that they could live on $200,000 per year (95% of their current income) and would require that level of income for approximately 30 years (based on their life expectancies).
- Ron and his advisor, using their agreed-upon estimate of a projected rate of return, calculated that Ron's non-business investments assets would be worth approximately $500,000 in five years (Ron's desired exit date).
- Ron's advisor calculated that the amount of investment capital needed to pay Ron and his wife $200,000 per year for the duration of their lives (based upon current actuarial tables and assuming a 7 percent investment return*) beginning five years hence is approximately $3 million. Thus the net (after tax) sale proceeds from the sale of the business must be $2.5 million, or between $3 million and $3.5 million pre-tax.
- The business is today worth between $1 million and $1.5 million.
Bottom Line: The gap between what Ron has today and what he needs to retire on his terms is about $2 million. Therefore, Ron must increase the value of his company by at least $2 million if he is to exit on his terms.
This is why Ron needs at least five years to plan and why he must start today.
Many of you can identify with Ron's situation because you face the same challenges. Ron knows what he has to do and he has found the motivation to start the planning and preparation necessary to leave his business on his terms. Have you? How big is your gap?
For Ron, and perhaps for you, five years is a tick away. It's time to get busy.
Contact me for a recommendation about who can help you to determine your business's current value and the gap (if any) between what you have today and what you'll need in order to exit on your terms. We can help you to understand your ultimate objectives and what you must do to reach them. Contact us today if you'd like help getting started.