In my 20 years in financial services, I have spoken to hundreds, perhaps even thousands of business owners. In many of those scenarios the business was the single largest asset in their financial plan. Many of those owners could not give me an accurate number on what their business was worth. Let’s take a look at this number and why understanding the value of the business is so important for a business owner’s financial plan in this week’s Inside Look at Building Towards Wealth.
Many business owners don’t want to really retire. They love what they do. Many want to do it for as long as they are physically and mentally able to. Others would just go start a new business if they sold their existing one. However, there are some who want to sell and play more golf and spend more time with the grandchildren one day.
No matter what, you can either leave voluntarily, because you’ve sold your practice or chosen to retire, or you’re forced to leave your business involuntarily because you are no longer able to run your practice. Without proper planning, not choosing to leave generally means the latter option.
If you don’t want to “retire” you still need to put yourself in a position to make work optional. By being prepared to make work optional you are better prepared to sell the company if your priorities or interests change or if you are unable to continue in the business. Work optional simply means being financially prepared so that you can make decisions on your terms.
Either way, you should begin planning for that eventuality today and you just can’t do adequate planning without understanding the value of your company.
When putting together a financial plan you need to understand what your goals are. How much money would you need to feel like work is optional? It is easy to calculate how much you need to save to be able to withdraw $200,000 a year beginning at age 65.
For example, we are going to say that if you want $200,000 a year. You need to have five million dollars in savings and investments using the 4% rule. It’s important to keep in mind that following the rule doesn’t guarantee you won’t run short of funds. It is merely a rule of thumb used to help determine how much a retiree should withdraw from a retirement account each year. Results will vary per individual. For advice appropriate to your specific situation, please consult a financial professional.
For a non business owner, we would calculate how we are going to save and invest to get to five million dollars. With many business owners, their planning begins with “I’m going to sell my business for five million dollars when I retire.”
However, what happens with many business owners, is that even if they know what that number is they assign that value to their company.
The problem then lies in the fact that their business may or may not be worth five million dollars when they want to sell it. It may be worth that today, but there is no guarantee it will be worth that when they sell. There may be a path to get there but they may need to increase volume, margins, business practices or the business may never get to that value.
That is why it is so important to have an accurate business valuation. With a reasonable business valuation you can plan around either A) saving for the difference between the number that you want at your work optional age and the actual value of the business, or B) you can begin working on how to try and increase the sale-able value of the business to help meet your goal at retirement.
Part of the value of a good financial planner for a business owner, is to help them identify what the metrics are that may be able to help them improve their business, and not so much to fix those particular areas, but to be able to have the resources and the network to be able to make introductions for their clients so that they can fix those areas, whether it is needing outside sales, better accounting better inventory management, or bringing in an outside CFO to the company.
In preparing for a sale of a company, you often want to begin at a minimum three years before the sale date, although I would recommend you start today even if you don’t plan on leaving the business for another couple of decades.
Changing the value of the company could be as simple as running less personal expenses through the business, so that when you are preparing to exit the true profitability of the company is apparent. Or it could be as in depth as needing to rearrange the management team, and redeveloping sales processes. Whatever it is, It cannot be done overnight. This all begins with valuation. If you are a business owner, and would like to help, and would like to understand the value of your company and how it fits into making work optional, please reach out to me.