One of the most important goals of Exit Planning is to estimate post-exit financial security.  To do that, owners and advisors must have three key pieces of information: how much money is needed for retirement, the business value, and the value of the non-business assets of the owner.

In our experience, business owners tend to overestimate the worth of their business, under estimate the funds needed to live on in retirement, but often have a good handle on their current portfolio values.

How Much Money is Needed for Retirement?

The “true number” for each person is different because everyone’s situation is different.  There are a lot of factors that go into determining your financial needs in retirement. Two owners of the same company may have very financial needs and these differences should be reflected in their  “true number”.

There are many different strategies for arriving at this number.  Some people want to use an absolute number such as a nest egg of a certain amount maybe $1 million to $1.5 million as an example.  Some owners calculate needing 10-30 times your current income, or having assets or ability to generate 70-80% of your pre-retirement income.  Every variation or combination of assets accumulated, income, and annual personal spending has an advocate somewhere. One can even find calculators on the internet where you plug in various data and out comes your “magic number”.

The most obvious reasons for differences in expected financial needs are age and health.  Someone who is 70 typically will have much different needs than someone similarly situated who is 58.  Health and health care provisions is a huge factor at this point in time.  It is hard to know at age 60 what your health will be like at age 70.  Another important factor to be taken into account is your desire or ability to continue working part time to earn meaningful income if needed after selling your business.  You cannot always be certain of being able to generate meaningful income from a part time job when you retire.

Where you want to live, and your lifestyle expectations can also make huge variances in what financial resources will be needed in retirement.  One thing we know is that living in New York City will usually cost much more than living in Omaha but there are many other things we have to make assumptions about.  Do you want to scale back your lifestyle when you retire?  Many people feel they will spend less upon retiring, but in most cases the spending level stays relatively stable but the items money is spent on changes.  Maybe less on work related or educational spending but more on entertainment and travel.

I feel it is important to get a good handle on the current spending and ask some tough questions about future expectations.  Walking through an exercise to calculate a “must have” number and a “prefer to have” number is helpful.  If you are interested contact me and I can forward you a worksheet to help sort this out so you have a real world view of what your future needs may be.

Business Value

For most business owners a significant amount of their net worth is tied up in their business but many owners do not have a good handle on the value of their business.  There are many ways to value a business.  You can find a simple calculation version called “Value your business on the back of an envelope” free on the website ExitPlaybook.com that can be used as an easy starting place for analysis purposes.  There are many factors which go into a business valuation so many times it is very wise to have a valuation done by an expert to make sure you are using accurate information as you put together your exit plan.  Three of the most common methods of valuation are Discounted Cash Flow (DCF) analysis, comparable company analysis, and precedent transactions.

Discounted Cash Flow (DCF) is sometimes called the “intrinsic value approach” because it primarily attempts to forecast future revenues.  You are looking at the ability of the business to generate cash and valuing that cash flow based on how much risk is associated with the business and its ability to continue this stream of cash flow.  Different multipliers are used based on the industry and factors of the individual business, so it usually takes professional help to arrive at a realistic valuation.  There are many different types of data that can go into these models and numerous different formulas applied to the underlying data so even businesses with similar cash flow can be valued differently.

Comparable company analysis as the name suggests compares the projected value of other companies to your company.  Multiples of  EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization) is the most common valuation method but other measures might include looking at comparable PE (price to earnings) ratios as well.

Precedent transactions is looking at business valuation compared to other companies which have been sold.  This involves looking at other transactions in the same industry using companies of similar size by assets, by cash flows, by trading multiples, geographic area, and other measures to determine potential value. This can be the most difficult method because there is much more subjectivity involved, but if similar companies have been sold recently it can be a good indicator of value and possibly also give some insight into potential buyers.  Depending on the situation this research may also give you the opportunity to talk with the owner of a previously sold business and learn from their experience.

Other valuation methods include: Asset-based valuation, ROI-based valuation, capitalization of earnings valuation, multiples of earnings, and book value. Some of these methods are actually used as tools within the three main valuation approaches mentioned above, but sometimes they can be used as stand-alone methods as well.

No matter which method(s) is used having current data is one of the key components to arriving at a meaningful valuation.  Old data may not reflect market or industry changes that happen every day which can dramatically affect valuations.  You are usually better off to engage an expert to help sort through the factors and arrive at a meaningful valuation, but at the end of the day the value is only determined by how much someone is willing to pay for the business.  Unfortunately many owners attach a higher than realistic value to their business because of their attachment to the business and knowing how much work they have done to build the business.  Having an outside valuation can help give the owner a realistic understanding of what their company is worth and avoid unrealistic valuations that can make negotiations difficult.

Factoring in the non-business assets of the owner

The last element we will talk about here is the value of the non business assets of the owner.  Most owners have a good handle on their current portfolio values but it takes planning to understand how to incorporate these assets into your exit plan.  This involves making assumptions about expected future performance of these assets and keeping them safe in light of fluctuations in markets.

The planning in this area may involve changing the types of assets you own and weighing the risk factors associated with different types of assets.  Your needs and expectations can change drastically as you begin to use these funds and transition away from an accumulation mentality to a usage mentality.   You may become more risk averse as you approach retirement age and you are most concerned that the funds will be there when you need them as income.

If you are someone who has always made his own investments, then you may be able to continue to make decisions to meet your investment strategy and goals.  The assumptions you make at this point in your financial life are critical to funding your retirement financial needs.  This may be a good time to engage a financial expert to help sort through and understand the complex rules and tax strategies associated with reaching the retirement stage of your career and achieving the financial security you desire.

Conclusion

The assumptions you make as you look at your financial needs in retirement, the business value and the value of the assets you have accumulated outside the business can have a big impact on the financial security you are trying to achieve.  Many people fail to truly identify or make poor assumptions of what their financial needs will be when they retire, and may have an unrealistic assumption of what their business is worth.  The earlier these items are understood will give you the best opportunity to make changes and plan well for your retirement needs.  Having expert help to understand these pieces and to help manage your investment assumptions without emotion or attachment can help to make sure you reach your financial goals up to and through retirement.

Prov 15:22  “Plans fail for lack of counsel, but with many advisers they succeed”