ILMA Compoundings - May 2019 - 38

BUSINESS HUB

Thinking About an Exit?
Begin with the End in Mind
By Dan Doran

S

tatistics tell us that for most
entrepreneurs and family business
owners, their operating business
makes up about 80 percent of their
net worth. What's more, most business
owners we work with are what we think
of as "business rich and cash poor."
They've built a very valuable - yet
very illiquid - asset. The vast majority
will rely on the liquidation of this
asset in order to meet their retirement
goals. While that liquidation may be
a traditional mergers and acquisitions
(M&A) exit (i.e., a sale to a strategic or
financial buyer), another viable option
could be a sale to family members, to
management or even to employees.
Regardless, if the proceeds from the
transfer are needed to fund retirement,
creating a financial plan focusing on the
liquidation outcome is the cornerstone
of sound transition planning.
WHY TRADITIONAL FINANCIAL
PLANNING OFTEN FAILS
In one sense, it's hard to knock
financial planning. For the most part,
financial planning embodies every bit
of sound advice we've ever received:
Be prudent with your money, save
well, invest wisely and plan for the
future. Most financial planners utilize
sophisticated modeling techniques
that are designed to help their clients
understand what their retirement will
look like based on their anticipated
spending level, savings rates and their
current assets. In fact, most planners
frequently use a Monte Carlo simulation, running 10,000 simulations
of their financial plan in order to

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MAY 2019

| COMPOUNDINGS | ILMA.ORG

"Most business owners we work with are what we
think of as 'business rich and cash poor.' They've
built a very valuable - yet very illiquid - asset."
help assure a 95 percent (or better)
outcome. What could go wrong?
Modeling using Monte Carlo, or
any other technique for that matter,
follows the old adage "garbage in,
garbage out." Remember that for most
business owners, the preponderance
of their net worth is tied up in their
business, and liquidating that asset
is required to fund retirement. That's
an incredibly important input to any
financial model: How much will owners actually be able to walk away with
when they transition ownership?
In my experience, most financial plans
for business owners are constructed
using a guesstimate for this number.
Putting a finer point on this - the
most important input to the model
that helps guide retirement is a guess.
Having been involved in thousands of
valuation assignments, I can tell you
with incredible certainty that this guess
is almost always too high.
GETTING IT RIGHT
Well before going to market, entrepreneurs need to understand two numbers.
First, after all taxes and fees, how much
do they need to walk away with from
any transaction? This is where traditional financial planning shines. A good
planner will work with them to understand their lifestyle needs and turn that
into a financial plan that makes sense

for them. Second, the owner absolutely
must have a realistic understanding
of the current market value of his or
her company. The key word there is
realistic - having a best guess isn't
helpful and potentially undermines the
whole financial plan.
With these two numbers in hand -
what business owners need from a sale
plus where their current market values
stand - owners have essentially created
a road map for where they need to
drive the company. Is their company
currently worth $15 million while their
financial planner helps determine they
only need $10 million upon leaving?
Great. They're well positioned to
transition at the time of their choosing. On the other hand, what if those
numbers are reversed? If the business is
only worth $10 million but they need
$5 million more, then it's obvious that
there is some significant work to do.
So, what's next? They need to create
a growth plan that is geared not just
toward revenue growth, but also
toward growing enterprise value. We'll
cover that in our next article.
Doran is the founder of
Quantive, where he oversees
the firm's business Valuation,
Exit Planning and M&A
practices. He can be reached at 202-2734-6490
or dan@goquantive.com.
http://www.ILMA.ORG
ILMA Compoundings - May 2019

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