Business owners have always sought, with varying degrees of success, to create a stream of income after we exit our companies that matches the income we enjoy while owning them. Today, the difficulty of that task has increased exponentially for three reasons.
- The growth of the S&P 500, including dividends, has averaged 4.25 percent in this century and the current yield on the Treasuries is 1.8 percent. This means investment growth and income has remains stubbornly low. So today’s post-exit investment income is far lower than pre-2000.
- Earnings multiples that buyers are willing to pay for businesses worth a few million dollars (and less) do not seem to have risen as much as multiples for businesses worth $5,000,000 and more.
- Life expectancies for you and your spouse have risen.
Our post-exit income streams have to last a lot longer than most of us anticipated, so it is very difficult for owners to exit their companies and maintain their pre-exit lifestyles.
Recall Larry Dykes from the prior post. His company’s valuation of $2,500,000 was based largely on a multiple of its pre-tax earnings of $500,000 to $750,000. As a mature business with no debt and little need for cash flow to fund growth, these pre-tax earnings could be distributed to Larry as “S” distributions. Upon a sale of the business for $2,500,000 cash, Larry could expect, after taxes and costs of sale, proceeds of $1,800,000. Once he invested the proceeds, Larry could withdraw 4 percent per year—a rate currently deemed reasonable by most financial planners.
Larry’s income stream from his sale proceeds is less than $75,000 a year—a tenth of the stream available to him pre-sale (and that’s without considering Larry’s pre-exit salary of $250,000 which he will not receive after he exits).
Larry and his wife lived on $300,000 annually. To maintain that lifestyle post-ownership, they would need capital of approximately $7,500,000. Even at that, the additional pre-tax earnings of up to $750,000 would no longer be available
Small wonder then that many owners feel compelled to continue in their businesses beyond their hoped-for exit date.
How Can You Create Sufficient Post-Exit Income?
- Prepare for your inevitable exit by investing the excess distributions you receive today from your business. Larry was able to invest $250,000-$400,000 a year—the after-tax amount of the earnings that could be distributed to him.
- Focus on growing business value and cash flow. Engage in an exit planning process with skilled advisors. As part of that process you will focus on methods, tools and designs to increase transferable value. A side benefit of this process is that your role will likely change—for the better. Your day-to-day “hands-on head-down” efforts must give way to a “head-up hands-off” if the company is to have full value without your leadership. I find that owners find much greater enjoyment in doing what they do best, rather than doing what they believe they have to do.
- Accept that you may have to remain in the business longer than you planned. Prepare yourself and your business for this reality.
The longer you wait to accumulate outside wealth, grow business value and carry on as usual, the longer you will remain in the harness.
The alternatives to tackling the task of creating sufficient post-exit income are:
- Remain in the business indefinitely.
- Exit and reduce your lifestyle.
The consequences of staying in your business or exiting it are dramatic, but the great thing about being an owner is that the decision is yours.
The reality for most successful owners is that only way to achieve our aspirations is to bring grit and determination to tackling the challenges we face and to create a strategy to overcome them.
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