All too often, business owners lack knowledge of the true value of their business. Moreover, many may not truly understand the cost of financial independence, or the money needed to maintain their lifestyles. These oversights, combined with the intent to rely on the eventual sale of their business for retirement, could be financially devastating.
The factors that come into play are academic. Maintaining an attractive lifestyle is expensive. As a rule of thumb, for a 60-year-old it takes about $1 million in savings to produce an income of $45,000 per year for the rest of his or her life, keeping up with inflation. Following this estimate, a lifestyle of $200,000 to $300,000 per year may require $3 million to $5 million or more in savings, plus Social Security at retirement.
How do you know if your business is worth enough for you to retire? Many businesses are best evaluated and valued on their ability to produce free cash flow. The simple definition of free cash flow is the profit that a business produces over and above the owner’s salary and necessary capital investments.
In many cases, owners who take a large salary but have little involvement in the operations of the business can significantly improve free cash flow. They may be replaced by a less expensive resource upon the sale, with the balance of their salary contributing to free cash flow. On the other hand, this is complicated by owners who are heavily involved in their businesses. If the business requires the same talent to keep it running after the sale, a highly paid individual or new owner will be required, leaving very little free cash flow to service the debt of the purchase.
To avoid jeopardizing retirement plans and goals, business owners should survey the current, true value of their businesses, as well as learn about the factors that influence value, such as free cash flow, business life cycle, and market conditions unique to their offering. Equally important is how this relates to the unique balance between their personal balance sheet and the cost of meeting their lifetime income obligation.
President and Founder
McGervey Wealth Management
North Canton, Ohio
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