Today’s newsletter is written to address an important topic in planning for an owner’s transition, namely, ‘how to get to the equity in your business?’ We’ll look at how business owners view their companies and then offer some planning-base suggestions as to how to draw the equity out of your business over time, assuming that you are not selling to an outsider. We hope that this newsletter content inspires you to begin planning for how you too will get to the equity in your business.
Getting to Income vs. Equity
There are two very different aspects to getting the money out of your business. On the first hand, there is the income that you draw from the business in terms of salary, personal/business expenses, and bonuses that you pay to yourself and/or retirement plan savings. All of this constitutes money that’s coming to you from the cash flow of the business going towards the lifestyle that you have built for yourself. The second and potentially much more important aspect, is getting to the equity – the illiquid part – of your business. The equity is your ‘owner’s value’, the reward for growing your enterprise and taking the risk as a shareholder and investor.
Leading with Personal Planning, Measuring the Value Gap
As a part of the process of tapping into your equity value, it is helpful to first know your Value Gap – i.e. how much money you need to extract from the business in order to maintain your lifestyle without the business. The chart below helps to illustrate this point.
We see that Bill Brown has $1,000,000 saved for retirement but needs $7,000,000 to maintain his lifestyle. Bill’s Value Gap is $6,000,000. The question becomes, ‘How can Bill get to the equity in his business in order to close this Value Gap?’
Like most business owners, Bill is focused on running and growing his business. Bill has some money saved for retirement. However, as we can see, it is nearly impossible for Bill to extract enough ‘income’ from his business, at his age, to meet his personal financial goals – Bill needs to get to the equity in his business. The question that Bill is looking to answer is, ‘how can I plan to tap into my business equity, over a long enough time period, to draw it out to meet my personal goals (without hurting my company’s cash flow)?’
The Many Paths to Harvesting Equity Value
The first step is to realize that there are many ways to get to the equity in your business. You can find a buyer, groom a successor, or even create a buyer for the shares of your company’s stock. The most important part of this planning process is to recognize that any one of these options requires a process.