(Three) 3 Important Options if You are Ready to Move On

If you are ready to move on from your business, it may not be a clean-cut as you hope. An outsourced CFO and business advisor can help you work through your options.

When was the last time you calculated the percentage of your net worth tied to your company’s value?

When you started your business, its value was probably negligible. Unless you purchased or inherited your company, it wasn’t worth much when you opened your doors. Then, over time, the proportion of your assets tied to your business may have crept up.

Let’s imagine a hypothetical business owner named Tim, who starts his company at age 30. He has a little bit of equity in his first home and a small retirement fund. When he starts his business, it’s worthless, so it doesn’t yet factor into Tim’s net worth calculation.

By the age of 50, Tim has built up $600,000 worth of equity in his home, and his retirement has grown to $400,000. The good news is the business has blossomed and is now worth $4,000,000; the bad news is that Tim’s company has crept up to represent 80% of his net worth.

The Freedom Point

What’s more, he may have unknowingly passed something called “The Freedom Point,” when the net proceeds (i.e., after taxes and expenses) of selling the business provides enough money for him to live comfortably. Your lifestyle determines your Freedom Point, but when you pass it, it’s worth considering the risk you’re taking.

If this pandemic has taught us anything, it is that any business can turn into a struggling company overnight. When your business makes up most of your net worth and a sale would provide enough money to retire, there’s no financial reason to continue owning your business. You may enjoy the challenge, the social interactions, and the creative process of building a business, but keeping it may be an unnecessary risk.

At this point, a fractional CFO can help you in many ways. This advisor can give you thoughts on a valuation, prepare your financials for review, and be a sounding board.

Manage the Freedom Point

When you’ve crested the Freedom Point and want to diversify—but still don’t want to retire—you have some options:

• Sell a Minority Stake: In a minority recapitalization, you sell less than half of your shares. Often sold to a financial investor such as a private equity group, this step allows you to diversify while continuing to control your business.

• Sell a Majority Stake: In a majority recapitalization, you sell more than half of your shares to an investor who will likely ask you to continue to run your business for many years to come. You get to diversify your wealth, keep some equity in your business, and continue to run your company.

• Earn-Out: When you sell your company, you’ll likely have to agree to a transition period of sorts. One of the most popular is called an earn-out, where you agree to continue to run your company as a division of your acquirer’s business. Your earn-out may be as little as a year or as long as seven, but the average is three years.

Building a successful business is rewarding, but when your personal balance sheet is the dominant asset, consider the risk you’re shouldering and the options you have for sharing some of it.