As a business owner considering a transfer to new owners, one of the most important steps you can take is calculating your Wealth Gap and figuring out how to fill it.
This process includes:
- Taking stock of the assets you have saved outside the business (your personal Net Worth)
- Determining how much income you will need post-transition
- And then calculating your Wealth Gap or how much money you will need from the proceeds of the ownership transition
The problem is that most business owners are not wealthy outside of their businesses—their businesses are their largest assets. Most owners don’t have an adequate nest egg and will be dependent on the sale of their business to fill this gap. In other words, they will need to extract money from their company in order to achieve financial independence, which can prove to be problematic in many cases.
So what can you do to avoid this pitfall?
Asset Diversification Provides More Options
Diversifying your holdings by saving money outside your business will give you more flexibility and choice when it comes time to transition your business to others. For example, owners who have saved a lot outside of the business may be able to afford to give the company to family members or key employees who are unable to pay for the company. It’s very appealing, especially if owners want to keep the business in the family or reward loyal employees who have made significant contributions.
However, very few owners are able to exercise this option. Only a very small percentage of owners may actually be able to afford to gift the shares of their businesses to others. Most owners will need to get at least some money from the transition to fund their post-transition lifestyles.
What Are Your Post-Transition Income Needs?
In addition to taking stock of non-business assets, the other essential component to determining how much money will be needed from the transition is analyzing your current and post-transition personal-income needs. You may have a simple or very extravagant lifestyle, to which you have become accustomed, and you, no doubt, expect that lifestyle to continue beyond the company.
Knowing exactly how much you will need to live your desired lifestyle will be critical to understanding just how much you will need from your business.
Other Income Sources
You may have sources of income besides your salary, bonus, and company-paid personal expenses. These might include real-estate rental income, interest, dividends, and eventually social security although you may not want to include this if you believe the system will be tapped out by the time you leave the business. If this is the case, you will need less money from the business ownership transition than those who are completely dependent on their business for their income.
Owners need to be careful not to have too many of their assets tied up in one basket—their businesses! For owners who plan to keep their businesses in the family or provide for future generations, it is critical to develop a holistic investment plan that diversifies their assets but keeps their business interests healthy and growing.
If you prepare well in advance of any kind of business transition, you can be proactive about saving more money outside of the business, therefore lessening your dependence on the business and the upcoming ownership transition. You can also assess where the business is in its lifecycle and determine whether and how many family members should be involved at any one time. This analysis and proactive action can have a dramatic and positive impact on the family and its financial well-being.