Creating Value
Are you getting the most out of your business?
I’ve been speaking with and working with private business owners for more than 15 years. Most owners have a dream of running their business for their working career, finding a buyer and then riding off into the sunset with no other planning.
Lately, I have been sensing that business is getting better, and I have been told that buyers are starting to make offers much richer than they were even last year. But before you decide to think about selling your business, you need to think through whether you can afford to sell your business. I encourage you to do the math carefully before you make the move to sell.
First, let’s consider some bracing statistics about private businesses that come from the Census Bureau.
- There are approximately 6 million private businesses that employ people in the United States.
- Only about 300,000 of these businesses do more than $ 5 million in sales.
- Only about 150,000 of these businesses do more than $10 million in sales.
- Private businesses on average sell for between three and six times their earnings before interest, taxes, depreciation and amortization, or Ebitda.
- The average private business has an Ebitda that falls between 7 and 13 percent of annual revenue.
So, let’s run the numbers on a simplified example. Suppose we take a business that has $10 million in revenue and an Ebitda of $1 million, or 10 percent. If this company is put up for sale, the transaction might look something like this:
- Revenue: $10 million.
- Ebitda: $1 million.
- Sale price of 4.5 times Ebitda: $4.5 million.
- Taxes and expenses on sale (35 percent): $1.575 million.
- Net proceeds from sale: $2.925 million.
- Pretax annual income available at 4 percent of invested proceeds: $117,000.
And there you see the conundrum that many business owners face when contemplating the sale of their businesses. Keep in mind that in this example, the owner — before the sale — had been enjoying $1 million of annual cash flow before interest, loan principal payments, capital investments and taxes. And this is one of the lucky few businesses in America that have annual revenue of $10 million, one of the top 2.5 percent. Does your business create more than $1 million in Ebitda? Are you in the top 2.5 percent?
If not, and if you are hoping that you might one day be able to leave your business, you might want to consider the following strategies:
Start and fund a qualified retirement plan. I call this prefunding your buyout. While your business is creating significant cash flow, take $40,000 to $60,000 and put it in a qualified retirement plan. If you are able to get a 6 percent return and invest $50,000 a year for 20 years, you will generate a nest egg of approximately $1.8 million.
Qualified plans are complicated beasts. There is a great deal of customized design that can go into your plan. The people in the qualified plan world who are experts at plan designs are called third party administrators. You will want to find one who understands the various options. Your accountant or investment adviser should be able to point you in the right direction.
In many cases you can tell your adviser how much money you want to save, and he or she can put together a plan that fits those parameters. I’ve seen business owners who got a late start save as much as $200,000 a year in their plan.
Think about owning the real estate. If it’s possible for you to purchase the real estate where your business operates, you should strongly consider this. Many business owners who own their own real estate end up selling the business but keeping the real estate and collecting rent.
Like a qualified retirement plan, starting early with real estate is important. Many owners will buy their business’s real estate and pay rent to themselves for 15 years to pay off the mortgage. After the mortgage is paid off, the rent flows to the business owner. Sometimes, the income from the rent is more than the income from the principal on the sale of the business.
Do a financial plan first. I have seen business owners sell their businesses, think they are going to retire and then find out four or five years later that they have to go to work for someone else. These owners often wind up with seller’s remorse. They wish they didn’t sell their business after all.
Doing the financial plan can help you figure out your financial needs before you start to plan the sale of your business. And advanced planning while you have strong cash flow can help you avoid the mistake of assuming that selling your business, even for millions of dollars, will cover all of your retirement needs. Once you sell your business, you don’t want that assumption to come back and bite you.
Have you thought about what it’s going to take for you to leave your business?
Josh Patrick is a founder and Principal at Stage 2 Planning Partners where he works with private business owners on wealth management issues.
Article source: http://boss.blogs.nytimes.com/2012/09/20/do-you-really-expect-your-business-to-get-you-through-retirement/?partner=rss&emc=rss