“My business is my pension” – I regularly hear this phrase and believe it to be one of the biggest myths in business.
You may also have heard this statement many times and possibly said it yourself. The truth is only a few smart entrepreneurs can say they have taken all of the correct measures to ensure they will have a great pension when they eventually retire.
Sadly, for many, the harsh reality of their lack of planning and poor long-term decision-making will be a date with destiny, and not a pleasant one.
Having worked with many accountancy firms over the years, it amazes me how few business owners consider the important subject of retirement or their exit from their business. Of course, some savvy entrepreneurs invest money in property or other asset-based products with the view to expanding their portfolio over the years which, in turn, will sustain them throughout retirement. Smart.
For some business owners, this is simply not an option, working long hours to keep the wolf from the door and feed their employees and their families.
I know many accountancy firms would like to do more for their clients but there isn’t a willingness to discuss this subject and make appropriate plans. The mindset of the business owner is therefore key in tackling this subject. What are your thoughts right now as you read this article? Are you simply curious or are recognizing that you need to do more to ensure your business is an asset worth selling? If and when you are ready, do you know what to do to change the course of your business?
Some business owners are living in an alternate reality. It’s a world where they believe they can sell their business for a fortune and then drive into the sunset to enjoy a new life in retirement. Sadly, somebody will wake these people up someday BUT, that may just be too late to save them from disaster. Let’s hope that’s not you.
Here are the big questions you must answer:
- How much is your business worth today?
- What price will you sell your business for, when you eventually sell it?
- Which year do you wish to sell your business?
OK, now that we have some raw data, let’s take a look at an example…
Your business is currently worth £100,000 and you wish to sell it for £1,000,000. You decide that you will sell your business in 20 years. (Note; most clients have considerably shorter timescales.)
What you are saying is that you need to grow your business 10 fold over the next 20 years…very possible.
Let’s push the reality button…
How much will £1,000,000 be worth in 20 years? With inflation compounded over the years, £1,000,000 will be worth considerably less in spending terms.
Remember, when you sell your business you will have tax to pay too. Nobody can sensibly estimate the rates or tax laws in 20 years. However, let’s say that you will pay capital gains tax. I’ll be generous and apply a tax rate of 25%. So, your £1 million is reduced to £750,000, or you need to sell for approx £1.34 million to net £1 million. I wonder what this will be worth in real terms in 20 years?
And the game plan is?
Aha, this is where I usually get blank looks! Is it that the penny has dropped? Yes, there’s a LOT of work to do. I’ve seen many business owners who thought that all they needed to do was ride out the next few years and then they can easily sell up. When presented with this information, can you imagine the fear and dread on their faces when they realise they won’t have sufficient funds to retire?
Some business owners are lucky as they still have time to re-think, set new goals and get on with the task of building their business with the aim of selling it.
Is it all doom and gloom?
Not necessarily. Here’s what you can do if you want to build your business as a saleable asset in the future. Note the phrase “saleable asset.” This is important and should be at the center of your present and future decision-making and planning. Let’s walk you through the process.
There are different ways to value a business, but a common approach is to use a multiple of net profit. For the sake of this and the following article, let’s use this common method of valuation although I appreciate it may not be the case in your particular industry sector.
Based on a multiple of five times net profit (this is considered a low multiple), let’s re-engineer your business.
- What is the average net profit figure you must achieve in the final three years prior to your retirement? You will need an average over three years to demonstrate strength and stability in your business.
- Based on your average net profit, what is the value of turnover required to achieve these net profit figures.
- Average the turnover figures into months. Is it achievable with current resources? If not, list what your business must look like in respect of
a) Fixed assets
b) Staff
c) Cash resources/finances
d) Number of customers
We could go further but this will depend on the timeframe you set to sell your business. If five years or less, then add a breakdown of product/service lines.
When you have calculated these figures, reverse engineer the numbers to the end of this financial year. This means looking at your existing business based on the calculations completed earlier and recognizing there is a gap. Knowing what this gap is, you set goals for each year which provides the necessary resources and sales to achieve your final three years figures.
You have just taken the first step in setting your goals for the business. Whilst I appreciate there may be an element of guessing here, it is still more favourable to have undertaken this exercise and understood the figures and merely wish you will achieve a specific target by a fixed date…with no game plan how you will achieve it!
[bctt tweet=”Your business is your pension? Fact or Myth? Have you crunched the numbers?”]
In part 2 of this article you will discover the steps you need to consider and action required to drive your business forward to achieve your new goals.
