One Number Every Business Owner Needs to Know

Most entrepreneurs eyeing the exit have a “magic” number in their head—a price tag they feel they need to secure before handing over the reins. But few can show their math, leading many to overestimate the amount they truly require.

Why the disconnect? Because most entrepreneurs lack a set formula for their sale price. Some back into a figure based on a rough feeling of what their business should be worth. Others cite rounded numbers, like $10 million or $15 million, though somewhat arbitrarily. Only a small subset has undertaken a rigorous analysis to determine whether their dream bid is sufficient to achieve their post-sale financial goals.

Secure Your Core

You didn’t build a successful business by relying on guesswork, so why let it drive your exit strategy now? To calculate a more precise figure, start from the bottom, with spending. Project how much you think you’ll spend after a sale—without the benefit of running your expenses through your business. By combining this estimate with how your sales proceeds will be invested, you’ll arrive at your “core capital”—the amount of money needed today to sustain your lifestyle for the rest of your life with a high degree of confidence.

Take John and Jane, a 60-year old couple who are planning to sell their organic pet food business. John is determined to hold out for $30 million gross, but Jane encourages him to consider a current bid that will yield $18 million in after-tax proceeds. Will this suffice?

To answer, they estimate that they will spend somewhere between $250,000 to $350,000 from their portfolio each year once the business is sold. Starting with this baseline, we calculated their core capital assuming the proceeds will be invested in one of three ways:

• an ultra-conservative portfolio of all bonds,
• a conservative allocation (20%/80%) of globally diversified stocks and bonds, or
• a moderately conservative allocation (40%/60%) of globally diversified stocks and bonds

Depending on their portfolio mix, the couple’s core capital ranges from $9.1 million (moderately conservative) to $13.7 million (ultra-conservative) assuming they spend $250,000 (Display 1). But what if their spending trends toward the upper end of the range? At $350,000, the amount they’ll need to secure jumps significantly—from $10.5 million (for $250,000 spending) to $14.8 million assuming a conservative allocation.

 

Surplus Depends on Proceeds

That doesn’t mean John and Jane should ignore the value of their business. While their core capital is not influenced by valuation, their “surplus capital” is. The latter represents assets above core capital that the couple could give to friends, family, or charity.

For example, if John and Jane do receive $18 million in after-tax proceeds from the sale (Display 2), their surplus capital would range from $3.2 million to $8.9 million (depending on how the proceeds are allocated and how much they spend). This excess wealth could be earmarked for any number of goals—from funding a donor-advised fund to buying a vacation home and paying for college for their grandchildren.

 

Precision Pays Off

It is essential for entrepreneurs to determine their core and surplus capital requirements prior to consummating a deal. Most owners have finite opportunities to sell their business. Knowing whether you have flexibility around your target price—or you should hold firm—can strengthen your hand during negotiations. With your core and surplus underpinning your “dream number,” you’ll feel more confident accepting a bid that will ultimately sustain your lifestyle with enough left over to leave a legacy for charity and/or your heirs.

Business owners deserve a partner who will support them right from the start. For more thought leadership for entrepreneurs and business owners, check out the related blogs here.