Are you a business owner who enjoys financial security whether you sell or stay in your business? Will your lifestyle remain unchanged no matter which option you choose?
Or are you an owner who enjoys financial security only if you stay in your business? If you sell, will you sacrifice the lifestyle you enjoy today because your post-exit income stream will be dramatically less? The answer is critical.
If you are in the first camp, you could sell the business or you could decide not to.
If you are in the second camp, there is more money to be made in keeping the business than in selling it.
These questions are all resolved by answering one more:
Can you replace your current compensation with the investment income from sale proceeds and existing investments?
Let’s look at how one owner made the determination.
Larry started his building materials distribution company 25 years ago. Today, his salary is $200,000 per year and the company has $500,000 to $750,000 of pre-tax earnings (EBITDA).
Like many Boomers, Larry is thinking about life without the business. He isn’t burned out, but the entrepreneurial flame burns less intensely than it did in the early years. He knows if he continues to devote less than full effort to running the company, the business will suffer and he will be no closer to making a decision. “Maybe,” he thinks, “if I can live the way I want to, it is time to sell.”
Larry’s desire to live, after his exit, as he lives today strikes a chord with most owners. Few of us will exit willingly if it means sacrificing our current lifestyle.
Larry’s first step was to meet with a financial planner. Like many owners Larry had assumed that it took his salary ($200,000) to maintain the lifestyle that he and his wife enjoyed. He was surprised to learn that he and his wife required 50 percent more, or $300,000 per year. The Dykes’ additional spending of $100,000 per year had been fueled by “perks” and S distributions.
Step two was to calculate whether the Dykes could maintain their current lifestyle if they: 1) sold their business and 2) added the net proceeds to their existing investments (which totaled $1,000,000).
A business broker estimated a likely sale price for Larry’s business of $2,500,000 resulting in net proceeds of $1,800,000 (after taxes and selling costs). With $2,800,000 of investable assets, Larry’s financial planner recommended using a 4 percent withdrawal rate, or about $110,000 a year. With that and Social Security payments, the Dykes could expect income of $150,000 per year—half of what they were used to. As for the extra $500,000-$750,000 of pre-tax earnings (EBITDA)? Those would go to the new owner.
Unless they halved their lifestyle, Larry realized he had two choices if they sold today: slash their lifestyle by half or maintain their lifestyle but eventually end up in a trailer park. They weren’t willing to do either.
Unless your business currently provides a satisfactory lifestyle AND produces significant excess cash flow—EBITDA—it is unlikely that a buyer will want it. If it does attract a buyer, the proceeds from that sale will likely be far below what you need to replace your current income, let alone replace the excess cash flow that your company produces. You need to work with your financial planner and a valuation (or M&A) advisor to determine this. Relying on your own financial and value assumptions will likely send you straight to that trailer park!
Owners seeking to achieve financial security through the sale of their businesses are seldom successful unless they already enjoy financial security through business ownership.
Only owners who can sell their companies for enough cash to maintain their lifestyles even have a choice to sell or stay. Larry and most owners with businesses worth less than $5,000,000 or so do not have that choice. If they choose to sell, they also choose a lower lifestyle than they currently enjoy.
Once you know, with certitude, which owner camp is yours, you can begin the process of creating and executing a strategy to create more business value and cash flow while simultaneously re-examining your role and day-to-day involvement in your company.
In future posts we will discuss the connection between strengthening a company and reducing your involvement. This is what “successful owners who can sell their business for the money they need, but decide not to” have achieved.
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