Presented by T. Ray Phillips
MMS, Inc., a computer service business, had survived recent industry turbulence through the persistent efforts of its owners, Ralph McMillan and Janet Shaw. In fact, MMS had enjoyed good cash flow for the past three years and its future looked rosy. Successfully meeting these challenges made Ralph (age 59) more anxious than ever to leave the business and Janet (age 48) more than ready for Ralph to leave. But neither owner had a clear idea of how to proceed, who to ask for guidance or even how to take the first step.
Janet and Ralph had to find the starting line before they could run the course to the successful dissolution of their partnership.
Ralph’s Tasks
First, Ralph must assess his income needs and timing of his exit. He must determine how much of the purchase price he needs (or wants) on the day he leaves and how much he is willing to receive after he leaves (a Retirement Needs analysis). This is a very different question from how much his interest is worth yet the questions are related because the cash Ralph needs must be attainable from the sale of his interest.
Second, Ralph must obtain an independent valuation of his ownership interest.
Note: Ralph is unwilling to leave unless he exits with full value for his ownership interest (hence the need for the valuation) and unless that value is enough to meet his retirement needs (hence the need for a retirement income needs analysis).
Janet’s Tasks
Janet wants to balance the risk/liability she and the business will assume in Ralph’s buy-out with the opportunity for continued growth in the value of business interest. Since Janet is likely to be unwilling to buy Ralph’s interest—if doing so puts her (or the business) at too great a financial risk—she must secure a professional’s projection of the company’s future cash flow.
This cash flow projection with enable Janet to determine if the business will likely have enough cash flow (after Ralph leaves) to finance the purchase of Ralph’s interest without stifling the growth and prosperity of the business.
Ralph’s Exit Plan Design
Ralph’s Exit Plan should be designed to:
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Quantify Your Resources: The Ultimate Exit Test
Tuesday, December 13th, 2011Presented by T. Ray Phillips
In the first Step of The Seven Step Exit Planning Process™, you, as an owner, establish three primary exit objectives:
The date you wish to exit;
The amount of cash you want upon exit;
and Your choice of successor.
Today, let’s look carefully at that second objective: How much cash will you need from the sale of the company to enjoy a financially secure post-business life? For most owners this is a great starting point for determining when, or if, they can leave their businesses.
Peter Daniels was the 58-year old (fictional) owner of Daniels Food Processing, Inc. He had engaged his financial advisor to:
Set a realistic assumption for a rate of return on Peter’s investments;
Research actuarial information to determine average life expectancies for both he and his wife;
and Help him and his wife agree on and establish an acceptable post-exit annual income amount.
As part of this process, Peter and his advisor reached the critical question whose answer would determine Peter’s ability to retire on his terms: What must the value of Peter’s business be if Peter is to leave, as he desires, at age 63?
Like Peter, your resources are likely both in the business and outside of it. You need to know the value of both so you can determine if there is a gap between the amount of money you will need in the future and the amount you have today. This gap must be quantified and—to exit successfully—you must create and implement a plan to close that gap. Most owners retain an experienced financial planner to help with this project.
Peter and his advisor used the following process:
First: Peter and his wife (Pam) agreed on their future annual income needs. They believed that they could live on $200,000 per year (95% of their current income) and would require that level of income for approximately 30 years (based on their life expectancies).
Second: Peter and his advisor, using their agreed-upon estimate of a projected rate of return, calculated that Peter’s non-business investments assets would be worth approximately $500,000 in five years (Peter’s desired exit date).
Third: Peter’s advisor calculated that the amount of investment capital needed to pay Peter and his wife $200,000 per year for the duration of their lives (based upon current actuarial tables and assuming a seven percent investment return*) beginning five years hence is approximately $3,000,000. Thus the net (after tax) sale proceeds from the sale of the business must be $2,500,000, or between $3,000,000 and $3,500,000 pre-tax.
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Tags: exit strategies, indianapolis small business, Small business exit planning
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