Let a financial planner show you the variables involved in selling your business.
For many business owners, selling their business is one of the biggest financial transactions they’ll ever deal with. It’s an important decision that has significant ramifications for retirement (and other) planning. Which means it’s important to develop a financial plan before the sale of the business.
Business sales: How much can you get for your business?
Business owners usually have a good grasp of their revenues and expenses year after year, by the time they get to the stage where they’re looking to sell the business. Most of them have already done some due diligence. They know what multiples businesses in their industry typically sell for, as well as the factors that influence this number.
Accounting businesses typically sell for about 1.2 times revenue, for example. Smaller, solo firms are easier to sell, especially when they’re up to date with the latest software. If you’re an estate planning attorney, you also need to have up-to-date software to make your practice look more attractive. They have similar revenue multiples.
Insurance agent? Normally your price is between 4.5 and 7.5 times earnings. Other businesses run on different multiples, but a competent business broker in your field (or a search through recent comps in your area) can give you a range to expect.
If you know approximately how much you can sell the business for, then why do you need a financial plan before the sale?
You might be thinking that it will be easier to just wait until you have the money in hand before you do the plan.
How a financial plan can help you sell your business.
Once your experienced financial planner has set up your goals and examined your financial information, inputting the sale amount is a fairly negligible amount of work. In other words, there’s no difference in terms of you gathering information and your planner working through the inputs as to whether you do it before or after the sale.
However, some of the business information that goes into the financial plan is also what buyers of the business want to see anyway. If you put it together for the financial plan first, it’s ready to go when buyers ask. You may be able to shorten the time it takes to close the deal by doing the plan first.
More importantly, when you run the plan before the sale is complete, your plan will include different scenarios that take the variables inherent in the sale into effect. You might find that one type of sale is better than another, because it allows you to retire when you want to. A different type of sale might mean you have to consider working for a longer period of time. Something you’d much rather know beforehand!
The plan will also take taxes into consideration. If you sell your $1 million in revenue accounting firm for its expected 1.2 times, your bank account isn’t going to balloon by $1.2 million once you take taxes into account. You’ll end up with substantially less with a cash payment upfront.
3 key variables to plan for when selling your business.
One of the key variables, of course, is the sale price. If you have a business that Google decides to buy for 8 figures, whether the price is a little on the high end or a little on the low end probably doesn’t really matter.
But if you’re an insurance agent with $1 million in annual earnings, there’s a potential $3 million difference between 4.5x and 7.5x. Depending on your lifestyle and your goals after sale, that could have a big impact.
And let’s face it, many business owners tend to inflate the value of their business. It is, after all, the business they worked so hard to build for all these years. Of course they think the goodwill may be a little higher than it actually is, or the price should be at the high end of the multiple range.
The buyers, on the other hand, have no incentive to pay high. They need proof that the business is actually worth 7.5 times in order to pay that amount. It’s pretty common for mismatches like these.
Know the Different Business Sale Scenarios Available to You
When the business owner does a financial plan ahead of time, they can look at scenarios along the spectrum and see what the potential effects of a lower payout are. They might have a floor for the sale, under which they can’t achieve a good retirement or other financial planning goals they have. They might not be able to leave a legacy behind as they had planned. They’ll know ahead of time which buyers aren’t going to work for them.
Or they may realize that their financial goals (based on the gross number) are too lofty for what’s coming in after tax and need to adjust. Better to know this ahead of time!
The financial plan can also tell a business owner how long they can hold out for the higher end of the range. Do they need an infusion of cash within the next year, or will any time during the next five years do the trick? The business owner may be able to wait for that higher payout.
Many financial businesses, like accounting and financial advisory firms, don’t sell for all cash upfront. They’re paid a trail, or portion of the earnings (or revenue) from retained clients, until the balance is paid out.
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Structuring the Sale of Your Business
How to structure the deal is important to know before the sale happens. And before any buyers are approached, so no one thinks they’ve experienced a bait-and-switch. If a larger deposit is necessary to shorten the trail duration, the seller needs to know that before any agreement is reached.
If they can afford a longer trail and smaller deposit, that might make it easier for them to sell to someone whom they like but doesn’t currently have a big bank account. Maybe a child, or mentee, or younger partner in the business.
No one wants to sell with a smaller amount upfront only to find out that it puts their retirement plan in peril.
Preparing the plan ahead of time also helps provide the owner with an exit strategy. Does s/he need to stay on and earn a salary for a few years while the new owner gets up to speed?
Some buyers may want the owner to hand over the keys when the deal is signed, never to return again. Others may prefer to keep the previous owner on to make a more gradual transition. Knowing whether you need to stay on or not can provide leverage for the deal in other ways.
Prepare Your Family for the Sale of Your Business
A key benefit, at least in terms of behavioral finance, is that by planning ahead of time and knowing where the money will go, there’s less chance to spend the money inappropriately. When a big payment comes from (seemingly) out of nowhere, unprepared family members may see it as a windfall, and not the result of a carefully thought-out plan.
Business owners themselves are usually pretty frugal with their money! But spouses or children may not be. It’s helpful for those who have spendy family members to bring them along to the financial planning meetings. (Spouses should always attend anyway, even if they don’t deal much with the investments.)
Knowing where the money is going when it reaches the family makes it seem like just part of the process when the money actually arrives, if everyone has been in on the plans.
You might very well have decided to upgrade a family car or renovate the kitchen when you receive that first deposit, but you’ll have a budget for it.
The windfall doesn’t seem so sudden when it’s been planned for, discussed, and put on paper.
A financial plan helps you get the most from selling your business.
When you go to a financial planner who has the software but not the experience, you’re more likely to end up with a generic plan. Inputs go in the software, and outputs come out. Some of these software packages can generate hundreds of pages!
Some of the software packages have a blunt-force instrument that adjusts all the goals to bring the plan to survival. Your inexperienced planner can use this solve button.
But sometimes the results are ridiculous. Your budget might be cut in half to make everything work, which is usually not realistic at all. There may be some goals you need to give up on, or you may need to work longer than you originally desired. But both of these may be more palatable than halving your budget!
Experienced financial planners know that some issues and goals weigh more than others. If the plan doesn’t quite work, or the expected probability is too low, a CFP® professional who’s been in the trenches for a while has a good idea about what tweaks need to be made.
They can work with you to prioritize goals, so that you may give up on one or meaningfully reduce it in order to make the plan survive for your entire life.
A financial plan helps you get the most from selling your business.
In short, preparing the financial plan and discussing various scenarios and their expected effects prevents the business seller from unpleasant financial surprises after the deal is signed and closed. They’ll know which buyers they can rule out, if they have a minimum requirement for the sale price that allows them to achieve other financial goals.
If they’ve been thinking in terms of gross revenue, as many people tend to do, they’ll have the reality check of what the after-tax results will actually be. They’ll know if they need to structure the deal in a certain way to minimize taxes. Or if they can sell to someone who will need a longer period of time to pay off their commitment.
They’ll also be able to prepare their families ahead of time, which will help ward off any “windfall” spending. The plan will help reduce uncertainty for the spouse as well. Some spouses fear that the business owner is too optimistic, and having the financial plan at hand will help them realize that they will be all right, even in old age, as a result of the plan.
Are you thinking of selling your business? Email us to get started on your financial plan, so we can help you avoid those unpleasant surprises.
A financial plan from Platt Wealth Management
We are a fee-only firm that is a member of NAPFA (National Association of Personal Financial Advisors). We act as fiduciaries, putting your needs first. Both of our financial advisors are CFP® professionals, with years of experience in the field of personal finance.
We tailor our comprehensive plans to each client, ensuring that the plan is clear, well-organized and easy to follow. We continue to monitor the plans after they’re set up.
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Platt Wealth Management offers financial plans to answer your important financial questions. Where are you? Where do you want to be? How can you get there? Our four-step financial planning process is designed to be a road map to get you where you want to go while providing flexibility to adapt to changes along the route. We offer stand alone plans or full wealth management plans that include our investment management services. Give us a call today to set up a complimentary review. 619-255-9554.