Can You Afford to Exit Your Business?
by Gary Gardner and Hank James
Whether you can afford to or not: There will come a time when you will exit your business.
This is the first truth of exit strategy planning. It’s going to happen and you better plan so you can afford to exit.
The second truth is: You will make more money by keeping your business than by selling it.
When you look at the first and second principles together, you have a dilemma: You will leave your business, but to do so will mean less money for you. Even so, people sell and transition out of their businesses all the time. What goes?
It’s because the decision to transition out of your business will be some reason more important than money. It may be retirement, health, family, lifestyle change, terminal burnout or any of a myriad of other reasons.
Achieving Financial Independence
Or, it may be you can afford to exit; you have more money and resources than you need to achieve your life dreams. If you are in this position, your spouse is probably saying, “Why are you going to work every day?”
When you are in this position, you have achieved the freedom of financial independence!
How do you know if you are financially independent? It depends on your personal financial goals: For the rest of your life, what do you plan to spend in supporting your lifestyle, what do you plan to give away and what will be soaked up by taxes?
Determining the Investment Needed to Achieve Your Goals
One of us (Hank) had a mentor who said there is only $10 difference in being rich and being poor: If you had $5 more than you needed, you were rich or if you had $5 less than you needed, you were poor. The difference is probably $1,000 now with inflation, but the principle is the same. Decide what you need and decide what you have to do to meet your personal financial goals.
Once you have established your personal financial goals, you can determine the investment needed to support your lifestyle and fund your legacy giving. Planning gives you flexibility in minimizing or eliminating taxes on your exit.
To find the investment needed is not a simple calculation. Think of the variables: There is inflation, taxes, return risk on various investments, social security impact and expected life span. In addition, there is the investment allocation and philosophy to be considered. The result is not a specific number but a probability factor and takes into consideration thousands of scenarios, which could happen with your lifestyle and investments. It’s called a Monte Carlo Simulation; your financial planner has the computing power to do this for you.
90% Wealth Confidence
We recommend our clients strive for a minimum of 90% probability, which we call the Wealth Confidence Factor.
If the value of your personal investments plus the value of your business exceeds the minimum investment needed, then you are financially independent. You have achieved 90% probability of reaching your personal financial goals. You can answer, “Yes” to the question, “Can you afford to exit your business?”
If Your Answer is “No”
What happens if your answer is “No?”
You have three choices:
1. You can reduce your goals to reflect the value of your personal investments and your business.
2. You can do nothing and keep on keeping on, recognizing, anytime some unforeseen event may cause you to exit whether you can afford to or not—or it may be you keep the business long enough so your minimum investment requirements are reduced because of your reduced expected lifespan.
3. Or you can increase the value of your business.
For most people, choices 1 and 2 are not very desirable. So making the business more valuable becomes the preferred choice.
How do you make the business more valuable? Since the value of a business is a function of its cash flow, you need to increase its cash flow.
In order to increase the cash flow, you probably need to do something different from what you are doing now.
Increasing the Value of Your Business
You can make a myriad of small tactical changes, some of which you already know and some of which you can uncover by what we call a profit leakage analysis. This analysis compares your company to others in the industry and makes the changes that work for others to get your company in the top tier of performers.
In addition, you need to consider strategic changes. Possibly new markets, new product lines, new geographic areas are needed. Maybe you need to add new sales personnel or new equipment or processes. To do this, you need to do a strategic plan and execute it. Decide where you are, where you want to be and how do you get there. Assign tasks and responsibilities with schedules and follow up to assure completion.
As a part of your planning process, you need to decide on the specifics of your ultimate exit. This brings us to the third exit strategy planning truth: The sooner you plan for ultimate exit, the more flexibility you will have to enhance the after tax value of your business.
Some tax minimization strategies take years to execute, particularly should you plan an intergenerational transfer. And operational strategies vary depending on the ultimate buyer, i.e., would you run your business differently if you planned to sell it to your daughter vs. going public? Of course you would.
In addition to planning to increase the value, you will need to plan for succession. Who will be the next owner? Will it be a family member, an employee, a third party outsider? Will the next owner be an owner operator or will it be an investor?
Remember succession has two aspects: ownership and management. Both have to be dealt with in your succession planning.
The fourth exit strategy truth: Exiting your business will be an emotional event. We’ve identified over 80 emotional reactions owners of businesses have when transitioning out of their businesses; you probably have considered of some of them:
- Can’t gracefully let go
- Loss of status in the community
- Reduction of self worth
- What to do on Monday after the sale?
- Fear of dissention in the family as result of the transition
- Concern for loyal employees
- Fear the buyer will fail
- Fear of paying unnecessary taxes
- Fear of not getting a fair price
- Etc., etc.
Planning puts you on the path to financial independence and also lets you recognize and rationalize your emotions. It will still be emotional, but less so by far. With a solid exit strategy plan, you are well on your way to financial independence.
Suppose you have a solid plan to get to “Yes” on the question, “Can you afford to exit your business?” Can you afford to relax and let it happen? You are further along than most business owners, but you have another question to answer before you can relax. That is: “Can you afford to die at midnight tonight?” And it will be the subject of the second article in this series.
Ó Henry S James 2007
This has been adapted from an original article written by Gary Gardner and Hank James.
Hank James, from WealthTrax Inc., is an Exit Strategy Mentor based in the United States, and can be contacted on firstname.lastname@example.org