One of the questions we always ask when a business owner walks in our office is, “When do you want to leave your business? Often, the owner will laugh, and respond with “Yesterday. I might then ask when he or she realistically could leave. The most common answer to this question? Five years.
Five years sounds like a nice number. It’s long enough away that owners dream they might actually be able to leave. However, I find that if they don’t take very specific actions that allow them to leave, they’ll be saying “five years forever.
Consider one potential scenario. Let’s say your business makes $250,000 per year after taking out your own salary. Let’s also assume that salary is $100,000 per year. Of the $250,000 your company makes, you draw $75,000 for living expenses and leave $175,000 in the company for growth and tax purposes.
It’s now time to sell. You have a buyer who is willing to pay you enough money for you to net $1 million after taxes. This, you learn, is a usual multiple for your industry and gives you, after taxes, four times your average profits for the past three years.
You go to your financial adviser and ask him how much of this money you can spend every year. He says that a prudent investor would not want to spend any more than 4% of capital.
Here’s your basic problem. You used to receive $175,000 of income from your business each year. After your sale, you will only be able to spend $40,000 per year if you want to protect the capital amount you received for the sale of your business.
To help measure financial independence for our business-owner clients, I have created a tool that my firm uses called the Four Boxes of Financial Independence. They include:
Let’s take a look at how this might work in practice for a 50-year-old business owner. His adviser might make the following recommendations:
How do the four boxes work? Well, now he has a 10-year program that can get him to financial independence. Assuming a 6% return, the asset and income possibilities from the four boxes would be as follows:
The four boxes provide our owner with income of $196,500 per year. What does it all mean? Now, our owner can say -- definitively -- the he will be able to leave his business in 10 years, with the lifestyle he wants.