The most important financial event of a business owner’s career is usually the sale of the company they’ve spent a lifetime building. And while the significance of this event to the owner and his or her family, heirs, and colleagues is unquestionable, many business transitions are inadequately planned and often do not meet the family’s goals.
The concept of selling a business and moving into the next phase of life sounds simple enough, but the details of such sales are complex and require great effort and attention by the owner.
To determine whether or not to sell his or her business, an owner will likely need to answer three questions:
• To whom to sell?
• When to sell?
• For how much?
Each of these is critically important when making this decision but of particular note is determining the sale price of the business since that sum will support the lifestyle and life goals envisioned by the owner and their family after the transition. It’s also important to note that making a final determination of the net amount needed requires extensive analysis including an understanding of other available resources such as personal savings, investment real estate, social security and retirement plans.
Making the Initial Estimate
First, an owner needs to estimate how much they plan to withdraw from their account each year during the period being considered (such as retirement). There are several variables that will have a significant affect on the result, including the age at which they want to retire and the actual investment results.
The most appropriate sustainable withdrawal rate (SWR) must be chosen. An SWR is the percentage of the portfolio that conservative analysis has shown can be withdrawn each year and sustain the desired spending. Again, this number will vary depending upon the individual, the period being measured, the investment performance, assumptions about inflation, and whether there is an expectation that money will be left over at the end. And note that the SWR is not the expected return of the portfolio, it’s the percentage being withdrawn (it’s assumed that the portfolio return will help cover some of the withdrawals and inflation).
For example, Harvest Capital has conducted research over all 30-year periods from 1926 to the present and has determined that an SWR of up to 5.5 percent is possible. Therefore, using the SWR of 5.5 percent and assuming an annual gross withdrawal of $200,000, the original net amount required from the sale of a business would be approximately $3.6 million.
More than Just Math
While it is helpful to understand the mechanics of this process, making a final determination about the sale price of a business is much more complicated. As most private business owners know, there are several buyers to whom he or she can sell their company in order to maximize value but there are competing considerations for each. While selling to an outside buyer may generate the greatest gross amount that can be realized, the tax advantages of sales to insiders (current management or an employee stock ownership plan) may generate the highest net proceeds to the seller.
Further, understanding whether a business would actually be attractive to a buyer requires a candid assessment of key value drivers with one of the most important of those being leadership succession. Could the firm survive or even thrive without its current owner? This is a particularly difficult conversation to have with anyone, but most especially for the highly motivated and independent individuals who have started and grown their own businesses. And of equal importance to all of these considerations is an understanding of the business cycle as the firm’s value will ebb and flow with economic conditions.
The owner must also make a candid assessment of their personal spending habits. They must understand their current costs in detail and figure out how much of that will continue in the future. Many owners are often surprised by the amount it will take to duplicate the somewhat hidden personal benefits of business ownership. In many cases, private businesses pay for services that have both professional and personal benefits, such as with country club memberships. Does the owner intend to pay for a country club membership in retirement? Will the family vacation that has been planned around a business trip continue? Perhaps most importantly, how will an owner pay for a good healthcare plan once they are no longer employed by their firm?
Figuring out how much of a current lifestyle will survive into retirement is a difficult, detail oriented process that will appropriately involve a spouse’s input and agreement about which competing goods and services to keep and which new ones to add. At a minimum, such a process will be time-consuming and require more than one serious discussion.
Get the Help You Need
The owner should engage their professional advisors to help build a comprehensive plan for this singularly meaningful event. Investment bankers or business brokers can help discover and vet buyers and analyze market conditions. A business appraiser can provide an impartial valuation of the firm. A transaction attorney can shepherd the process and ensure its sound execution. An accountant can help manage the tax impact. A trust and estates attorney can build the best legal structures to minimize taxes and transfer wealth effectively. And a wealth advisor can provide financial planning, investment management and family wealth education services.
And if a business owner doesn’t want to organize and coordinate this process, a professional exit planner can do it with them. Indeed, the process that an owner uses to prepare for and then actually sell their business will often be more important to maximizing the value to be extracted from the enterprise than the underlying fundamentals of the business itself.
What If I Don’t Have Enough?
If you’ve taken a moment and used this framework to determine how much you will need to retire and are now concerned that you won’t have enough, consider working with your team to create your own transition plan. A good estimate of the net value of your business usually requires a thorough analysis by experienced professionals and this will likely add more accuracy to your understanding. Successful transitions take time—usually one to three years of good, solid planning—so the sooner an owner starts the better the likely outcome.
It’s All About Planning
Sound and thorough planning will focus on the value drivers of a business and can provide both an understanding of the factors that have created its current value and, in some cases, the efforts that can be undertaken to increase it. Comprehensive planning for both a business transition and a next step in life requires hard work and professional advice from a team of advisors.
James A. Fitts is a managing director and the chief planning officer and John F. Weeks III is managing director of family wealth and business transition planning at Harvest Capital Management in Concord. They can be reached at 603-224-6994. For more information, visit www.harvestcap.com.
Current Issue - April 2024