Start Now, Finish WellChia-Li Chien, Ph.D., CFP®, PMP®, CPBC
Chia-Li Chien, PhD, CFP®, PMP® May 9, 2018
This article originally published in May 2018, Speaker Magazine from National Speakers Association.
Is your retirement dream to sail into the sunset on the profits from cashing out your business? Following this advice can make the difference between sailing on a yacht or a dinghy.
You may be surprised to learn that one-third of all businesses in the United States closed without the owners’ cashing out, according to the Small Business Administration, as cited in my book Work Toward Reward. One-third of U.S. businesses transfer internally, and one-third sell to third parties. However, according to the 2015 Capital Markets Report by Pepperdine University, 11 percent of those who sell to a third party never close the deal due to insufficient sustainable cash flow.
The lesson? To finish well, you need careful succession planning now.
This article will help you prepare for your business succession to transition you into retirement with practical succession planning strategies to reduce risk while you build equity value.
What Makes a Business Valuable enough to Sell?
Before I get into the business model, let’s decide what type of business you have built so far. There are three categories of entrepreneurs described in my book Show Me the Money:
- TECHNICIAN. Your business can afford to pay you an annual salary of $100,000 or less. Please note, I said salary, not revenue.
- MANAGER. You have built a business that provides you with an annual salary of up to $250,000.
- BUSINESS ARCHITECT. Your business provides you with an annual salary of greater than $250,000.
There is limited salable business value if you are a technician entrepreneur. You will need to rely on your retirement savings to fund retirement. You must build equity value in your business if you wish to sell your business to support a portion of your retirement.
Here is what matters most when you sell your business. If you recall from your Accounting 101 class in college, the perpetuity business equity value is the discounted net cash flow. If you weren’t really paying attention during that class, or never took it, what that means is the expected future cash flows the business can sustain, discounted back to today’s cash equivalent.
Sustainable net cash flow comes from a viable business model. A viable business model generates sustainable net cash flow from diversified products and/or services, with or without you—the owner of the business.
In other words, what matters is if the buyer can continue to generate net cash flow from the company without you or your personal brand. Now you have a salable business.
Niche Is Rich
One practical strategy to create equity value is to reduce risk through niche subjects, thus making your business valuable from an investor or buyer’s perspective. There is a saying: “Niche is rich!” Consider this approach as you reevaluate your company and its value, regardless of economic conditions or competitive pressures.
The speaker business model generally includes products and services derived from a speaker’s intellectual property. The process of delivering the services or products is also intellectual property in to the extent it can be replicated through licensing or a franchised business.
This business model can combine with niche subjects such as sales, leadership, behavior, or even industry specifics. If the business model is built properly, the founder does not need to be in the business at all, and the company can continue to generate net cash flow.
Here’s How It Works
Let’s take a look at a case study. John is 64, has a speaking and training business in the insurance industry that is comprised of 80 percent in-person and 20 percent virtual services. There is one full-time administrator, daughter-in-law, Katie. John has a son, Jerry, who is not in the speaker business, but is a vendor of John’s business. Both Katie and Jerry have expressed interested in buying John out.
Good news! John has successfully built a speaker business niched in the insurance industry. John is considering an internal transfer where Katie and Jerry might buy John out. John’s timing of transition is critical. In general, the size and complexity of a business model determines which upon-exit method is selected in year one because the equity value can take up to five years to build.
In my experience, a smaller company like John’s takes time to build the equity value plus obtain qualified buyer’s financing to transition out. The entire exit time frame may still take four to five more years. If John does everything as planned in Figure 2, he will be about age 70 when he successfully cashes out.
The goal for John during the equity-building phase is to diversify his client/product concentration. One rule of thumb is that no one client or product should exceed 25 percent of the business revenue. John currently has 80 percent of his products in in-person training. He can further diversify either the type of in-person products or the clients.
The reduction of concentration can decrease the risk for his company and help the buyer to qualify for financing. Additionally, besides Katie as a full-time administrator, there is a need for John to build up a key management team to demonstrate that the business can sustain itself without John or John-as-a-brand.
Timing Is Everything
To start a business is hard, and successfully cashing out at the opportune time is even harder. What are the three major factors impacting real estate value, marketability and desirability? That’s right—location, location, and location.
The three major factors impacting exit from privately-held businesses are, logically enough—timing, timing, and timing. So, what’s the big deal about timing? According to private capital expert Rob Slee, author of the best-selling book Midas Managers, there are three significant timing factors that must be aligned when planning a successful business exit:
- PERSONAL TIMING. The readiness of the owner to move on to something else.
- BUSINESS TIMING. A substantial key management team able to operate with or without the owner or founder.
- ECONOMIC TIMING. Where the economic cycle is and if the client industry is trending up.
You have full control of the personal and business timing. Unless you pay attention to building equity value in your business now, the economic timing can take control of your business value. How much equity value you want to cash out and transition into retirement is entirely up to you. Start now.