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Remember Peter Daniels, our perennial procrastinator?
In 2005 Peter Daniels wanted to leave his food processing
plant in five years by selling it for enough cash to maintain a comfortable
lifestyle. A quick review of the company’s financials suggested that with a
current annual cash flow of $250,000, before his salary of $250,000, the
company would be valued around $1 million. Peter’s advisor suggested
creating and implementing a step-by-step roadmap to increase value,
minimize taxes, and protect existing value from loss, and Peter agreed, but
did nothing more. Peter never designed an exit plan nor did he ever
implement one.
Five years later in 2010, Daniels Food Processing, Inc. was
pretty much unchanged. But now Peter was frustrated. The economic downturn
caused downward pressure on business cash flow. Even more unfortunately,
Peter had addressed neither the need to: (1) create or update business
systems (especially any marketing plan), nor (2) restructure his inadequate
and under-motivated management team. Peter remained at least five years
away from his exit.
In our last issue we outlined how and why to make Increase
Your Company’s Value your first goal of 2010. In this issue, we will
talk about why Goal Two: Set Ownership Objectives is important whether
you’ve made the decision to exit or you just aren’t convinced that you want
to leave your company any time soon.
Goal Two: Set Ownership Objectives. As
Yogi Berra said, “You've got to be very careful if you don't know where
you're going, because you might not get there.” Setting ownership
objectives is about fixing your target or describing what a successful exit
looks like to you. The three primary exit objectives you must set are:
- On what date do you want to exit your company?
- Do you want an outside third party or insiders (key
employees, children) to succeed you?
- How much cash will you need from the sale of the
company to enjoy a financially secure post business life?
Like Peter, most owners depend on the proceeds from the sale
of their companies to create financial security for their post-business
lives. Let’s take a closer look at that third objective because, for most
owners the amount of cash they need for retirement dictates when they’ll be
able to exit (first objective) and whom they choose to succeed them (the
second objective).
In order to help Peter realistically estimate how much cash he
and his wife, Pam, will need for a financially comfortable post-retirement
life, Peter’s advisor worked with him to create a “Financial Needs
Projection” based on a variety of factors.
1. Years until desired exit: Peter is 58 and wants to
exit by age 63.
2. Assumed rate of investment return on personal
investments (both pre- and post-exit) : Peter and his financial advisor
agreed that a seven percent average growth rate was realistic given the
nearly zero percent growth rate for the past 10 years, but the nearly 10
percent rate of the last 25 years. You and your financial advisors will
pick a “realistic” assumption for you.
3. Life Expectancy: Peter and Pam are both 58-years old
with a 50-50 chance that one of them will reach age 91 (according to 2003
Annuity actuarial tables). Unless Peter (or Pam) plans to become a Walmart
greeter at 92, Peter needs to sell his company for enough cash to see one
of them past his or her 91st birthday.
4. Annual Income Amount: Peter assumed that he and Pam
could live on 50 percent of their current income. Pam, however, did not
want to cut back that drastically and found that the editors of Money
Magazine agreed:
“. . . . you'll need 70% of your pre-retirement yearly salary
to live comfortably. That might be enough if you've paid off your mortgage
and are in excellent health when you kiss the office good-bye. But if you
plan to build your dream house, trot around the globe, or get that Ph.D. in
philosophy you've always wanted, you may need 100% of your annual income -
or more.” http://money.cnn.com/retirement/guide/basics_basics.moneymag/index5.htm.
Peter agreed to base their retirement on receiving 80 percent
of his pre-retirement income.
5. Growth In Business Value: Peter has a good idea of
what his business is worth today, but he must figure out what its value
must be in five years to support the lifestyle he wishes to maintain. We’ll
explain how Peter and his advisors go about that task in the next issue of
this newsletter.
But Why Set Exit Goals If You Aren’t Yet Ready to Exit? It is
inappropriate to suggest that you, the creator of a business, should exit
before you choose. But the cold reality is that: 1) most owners (including
Peter and probably you) need to grow the value of their business
significantly in order to exit with the lifetime income they desire, and 2)
growing value takes time.
For that reason, knowing the size of the gap between your
company’s value today and the value necessary for you to retire comfortably
is the starting point for all planning. It dispels the tendency to
procrastinate under the mistaken assumption that planning and action can be
delayed and prompts many owners to take immediate action to grow and
preserve value.
Exit planning begins when owners understand their ultimate
objectives and what they have to do to reach them. Contact us today if
you’d like help getting started.
Subsequent issues of The Exit Planning Review™ discuss
all aspects of Exit Planning. The provider of this Newsletter (James Rice) offers you unbiased
information about what you may need to know — How To Run Your Business So
You Can Leave It In Style™.
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