Small-business owners frequently finance their retirement by selling their companies. That's fine, but many haven't stopped to consider exactly how much money they'll need from that sale of their business in order to live comfortably. In short, they need a cash figure.
Ignoring this critical issue and just hoping things will work out is rarely a winning strategy. But some effort is required here because answering this question is hardly a trivial exercise; so, if you aren't an expert in this area, you'll need to seek out pessional help. However, a few tips will get you moving in the right direction.
Develop a retirement budget in today's dollars.
Many of your current expenses will have gone away. For example, your kids will likely be self-sufficient and off of your payroll. The mortgage may be paid off. But you may also have some increased expenses. Many people plan to travel more extensively after they've reduced their work obligation.
Others want to be able to give more generously to charities they support or to help with the education of grandchildren. The first step is to estimate your annual expenses once you've retired.
Estimate any income you'll have in retirement.
Some people will have pensions. Social Security may also be around, but given the economics and the uncertainty, we don't include any money from Social Security in our calculations. You may have some rental property that will provide income.
Further, many people don't plan to fully retire. Rather, they plan to pursue a second career at a greatly reduced pace. If what you plan to do in retirement will generate income, that income will reduce your annual need.
Calculate the required size of your retirement nest egg.
Let's say that you have done the math and determined that you'll need $100,000 per year. How much money should you plan to have invested to cover this annual draw? Remember that the amount you take out will have to grow each year to keep pace with inflation. A somewhat conservative way to estimate this is to assume that you can take out 3 percent of what you have invested each year. That means that you would need to begin retirement with a little over $3.3 million in your nest egg.
Consider the effect of inflation.
That $3.3 million assumes that you will be retiring today. But suppose you don't plan to retire for 15 years. In that case, inflation will increase the amount you'll need to be able to afford the lifestyle you plan.
Let's assume that inflation runs at 2.5 percent for the next 15 years. To maintain purchasing power parity, you'll need to have $4.8 million socked away.
Take into account money saved.
Consider the money you've saved to date. Add to that the amount you think you'll be able to accumulate prior to retirement. Include any growth you expect to see from having that money invested. Say you expect to amass $800,000 from these sources. That would mean that you'll need to net $4 million from the sale of your business.
Estimate the needed size and profitability of your business.
A good business broker or another financial professional will be able to give you an idea of what your business will have to look like to fetch the price you need. Do your homework here. Find a broker that is reliable, ethical and knowledgeable. You should consider things like revenue, profitability, management structure and prospects for the future. Remember: If you are the business, it may not be worth much without you.
If the business already could be sold at this point, determine the changes necessary to get the price you need for your business. If you need to retire now, congratulations -- it's game over.
If not, you will need to determine how much growth, profit improvement and strengthening of the management team will be necessary to achieve your goal. How will you get your business to where it needs to be? The world changes, so you will need to recalculate these numbers every few years to make sure you're still on track.
This is where a good consultant can be helpful. We have worked with several business owners to get their business ready for sale. Don’t wait to get started. You'll often need five or more years to make the changes necessary to fetch your desired price.
Admittedly, none of this is an exact science, but having at least a ballpark estimate of what you need to do in order to attain your goal is much better than ignoring the issue and flying blind. As that renowned philosopher Yogi Berra observed, "If you don't know where you are going, you might wind up someplace else."