Keys to a successful exit of your small business [Transcript]
[Exit Stage Left logo]
[Plan Your Future Today]
[William S. Hart, MBA, CFP(R)]
[Retirement Strategies, Inc.]
William S. Hart:
What I want to talk to you about today is The Financial Preparations to Exit Stage Left. There’s really three areas that you need to be prepared. First is your personal financial preparation. Second is your business preparation. And then, the third is your mindset. So when you went into business, you probably had a business plan, and you looked at how much money it would cost you to run your business. You had some capital, and you had a lot of hope and ambition. Well, starting to prepare for personal retirement is much the same. So, when we get ready for personal retirement, we need some capital. We need to know where our money’s going to come from and go to in retirement, and we need to be ready to face the unknown there as well.
So I’m going to start talking about the risks in retirement. In your business, you had risks, and the risks, unfortunately, don’t end when you enter retirement. And some of the risks you have some control over or can influence, and some of them really are out of your control. So let’s start talking about longevity. Did you know that if you’re 65 years old and you’re a male, there’s a 20% chance that you’ll still be alive when you’re 90. If you’re a female, the chance is 30%. And if you’re a couple, the chances are 40% that one of you will still be alive when you’re 90. So if you retire at 65, and you live until 90, that’s 25 years. That might be longer than you owned your business. So I guess that’s both good and bad news. So longevity is great if you are prepared and can enjoy it, but not so great if you outlive your money. Next is inflation.
So over the course of 25 years, even a 3% inflation can double the cost of your spending. You really don’t have any control over inflation. You might be able to make adjustments to it along the way, but it’s something that we have to plan for. Third is the macro or the market risk. And really what we’re talking about here is, that’s the economic and the political environment that you happen to experience in your retirement. It can have a dramatic impact on the success of your retirement, but you have absolutely no control over it. And then the fourth area is spending. And of all the areas, it’s an area that you have the most control over. But what we’ll see in a minute is, even there, it’s not completely within your control.
So when we think about spending and you think about your business, you probably had a budget for your business so you could know what your spending needs were for the year. Well, it’s the same in your personal situation. But we want to think about our personal spending in four ways. The first way is, what we call, non-discretionary. And those are the things that really, you can influence them to some degree, but they’re pretty consistent over your entire life; your electric bill, the food that you eat around your home, property taxes, various types of insurance. You can have some impact by driving a less expensive car or living in a smaller house. But really, once you set your lifestyle, those expenses really don’t change much during your lifetime. Next is debt. Now, my best advice to you is to try to be debt free when you get to retirement.
But even if you do that, there might be expenses in your retirement that are better met using debt. Maybe you want to buy a motorhome, or a second home, or you have to do repairs to your home. And it might just be more economical to pay for that over time rather than all at once. And so, proper management of debt is important in understanding what those payments will be. The third is healthcare. So healthcare is a very significant expense for many retirees, and it’s something that increases faster than the general rate of inflation. So those are the three spending areas that you don’t really have a lot of control over. You can influence them.
So what we need to do is do a good job of understanding and being realistic about, what are those going to add up to? Because once we’ve covered those, then we can talk about discretionary. And really discretionary is where the fun happens. That’s traveling, that’s eating out, maybe helping family members. But we can only do that if we have money left over. So, just like with your business, you put together a business plan for the essential expenses and the things that would be nice to have, we’re going to do the same with your personal spending. So let’s suppose that we have our personal spending plan in place. The next important question is, well, where’s the money going to come from in retirement?
So the first thing that we would want to do is think about, do we have any recurring sources of income? Do you have a pension from maybe a former employer? Are you going to get social security? Did you pay into that? And if you sold your business on say an installment sale, are you going to be getting payments over time? So we want to schedule out these recurring expenses, subtract out any income taxes from those, and then subtract from that number all of our spending items. Now, for most people, the spending is going to be more than the income. So we’re going to end up with a negative number, which is a gap or a deficit. And how are we going to cover that deficit?
Well, that’s what’s got to come from your personal savings. So the question then becomes, how long does my money have to last? How much do I have to pull out of it every year, and what is my money going to do for me in terms of growing and earning? Well, we can’t know all those answers, because that gets into the risks we identified; the longevity, inflation, the market macro risk, and our spending. So the next best thing that we can do is really to model how that might look. So what we want to do is measure the success of our retirement under various situations. And by success, what we’re measuring is, what’s the probability that I can live my entire life, spend money doing all the things that I want to do, and not run out of money? So that’s how we’re defining success.
Because we can’t know how long we’ll live, what inflation will be and what return will get our investments, we want to model that under various conditions. That process is called Monte Carlo. It’s a process where we simulate many, many different outcomes, many patterns of return, to understand how much impact does that have on our financial security. And so, let’s say that we model that and we get a 91% confidence rate. What that means is that 91% of the situations that we looked at were successful. We had enough money to live our lives. Sometimes, we ended with a lot of money and sometimes, a little, but we had enough. And so that’s great. And it’s never a guarantee, so it will never be 100%. But let’s say that at 90%, we feel confident and we would like to consider spending more. And so, we create another scenario with even more spending.
What we see in this situation is our success rate drops down to 78%. Well, that’s still not bad if we have a fairly large discretionary spending. Because what that means is, if we get into trouble in retirement, we could cut back and move our success rate back up. So really, this process of modeling success is about just understanding the possibilities under different situations. You’re still going to have to monitor what’s actually happening every year during your retirement. So with that in hand, we have the basics of our personal financial preparation. We know where money’s coming from, where it’s going to, and how likely it is that it’s all going to work out. So now we want to turn our attention to our business preparation. For most entrepreneurs, your business is your most important asset. And so, if you’re going to get ready to sell it, you want to fix it up.
You want to make it as attractive as possible so that you can attract more buyers and get the best price for your business. Well, how do we do this? For every business, there are processes and procedures. And your new buyer, while they might know your industry, they don’t really know how you created success. That comes through in your processes and procedures. The more clearly and simply those can be defined, then the more confident that new buyer will have and the greater their probability of success, and so, the more that they’re willing to pay you for your business. Next is clean up your balance sheet. Balance sheets can be like closets. You can collect a lot of stuff in there that’s really not very productive. So go through, clean up your assets and liabilities.
You really want your balance sheet to be lean and clean. And then, if you’re like most business owners, you’ve got a to-do list. And if you’ve ever taken a two-week vacation and you look at your to-do list, and you think, “I’m going to clean that up before I go, so when I come back, I’ll have a fresh, clean slate.” Well, that never happens. Because your to-do list got that way over months and years. And if you could clean it up in two weeks, you wouldn’t have it to begin with. But what you do need to do is look at that list. And if there are important things to take care of before you bring a new buyer in, then do that. If there are things that you think would be nice to do, make a list, and present those to your buyer as areas of improvement. They might appreciate that.
So we’ve gotten our business cleaned up. The next thing that we need to do is get an opinion, and so, contact a business broker. They can give you both a financial and an operational appraisal. So the financial appraisal means, they come and they look at your numbers. And they compare you to benchmarks and say, “Given how you run your business, this is what we think is a reasonable price.” And they’ll probably give you a range. But many business brokers can also look at how you’re doing what you do, and maybe with a fresh eye, make some recommendations that would make your business more efficient, simpler, and then more valuable. So we’ve got our appraisal, our business is in good shape. Now we want to begin to understand the tax implications of selling our business, because there’s many ways that the transaction can be structured.
So meeting with a CPA and understanding the tax ramifications. You as the seller, the things that will be best for you are going to be worse for the buyer. So at some point, you’re going to find yourself in a negotiation over tax strategies. You want to understand your options before you get into that negotiation. Like any good negotiation, understand your options. Talk to your CPA about ways that if you do take on more of the tax burden, if there are ways for you to shelter that. So getting your tax strategy in place is a critical step. So finally, you’re getting ready to seal the deal, it’s critical to work with an experienced attorney to help you draft up a document to codify the sale. This is going to be especially important if you, the seller, holds a note. You sell your business over time.
You want to make sure you have a good collateral interest in your business so that if something goes wrong, you can step back in and take control and try to salvage whatever value is there. So I hope what you see through this is putting together a team of professionals is really a critical step to getting the most out of your business, and it takes planning in advance. So we’ve got our business plan in place, our personal financial plan in place. Now comes what might be the most difficult, which is mental preparation. So most entrepreneurs are very driven people, and it’s very difficult for them to think about not having something to do when they wake up tomorrow morning. So my advice to you is to begin thinking about this at least two years before you retire.
Start thinking about, what are the things that you do in your business and your personal life that really gives you the most fulfillment? Are there ways to carry that into retirement? If you liked developing employees and building your business, are there organizations that you could volunteer your time with where you could do some of those same activities and help other businesses out? So think about that and really put thought into that long before you’re ready to walk out the door. And then, finally, give yourself permission to have an empty schedule for at least six months. Probably, one of the biggest mistakes that we see is people going straight from the world of work to the world of retirement, and they’ve busy their schedule again.
And they never really figure out if they’re doing the things that matter the most to them and they give them the most personal satisfaction. So give yourself that permission. When you’ve started your business, the purpose of it should have been to serve you, your life, and your ambitions. And the purpose of your retirement is to do the same, your money in retirement is to do the same. Both pursuits took time, ambition, and planning to accomplish. But done well, it makes all the difference. So, thank you.
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