Frequently, small business owners plan to finance their retirement by selling the company. That's fine, but many have not stopped to consider how much money they will need to receive for the sale of their business in order to live comfortably. They don't know their number!
Ignoring this critical issue and just hoping things work out is rarely a winning strategy. Unfortunately, answering these questions is a nontrivial exercise and if you aren't an expert in this area, it's advisable to seek professional 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, the kids will likely be self sufficient and off of your payroll. The mortgage may be paid off. You may also have some increased expenses. Many people plan to travel more extensively after work obligations are reduced. 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 will have in retirement. Some people will have pensions. Social Security may be around, but given the economics and the uncertainty, we don't include any money from Social Security in our calculations. Many people don't plan to fully retire. Rather, they plan to pursue a second career at a greatly reduce pace. If what you plan to do in retirement will generate income, it will reduce your annual nut.
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?
Remember 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% 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. The $3.3 million assumes you retire today. Suppose you don't plan to retire for 15 years. 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% 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 have saved to date. Add to that the amount you think you will 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 other 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. 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.
Determine the changes necessary to get the price you need for your business. If it can already be sold for more than what you need to retire, congratulation - it's game over! If not, 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 this calculation should be repeated every few years to make sure you are still on track. 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 the renowned philosopher Yogi Berra observed, "If you don't know where you are going, you might wind up someplace else."
Know your number and have a plan to achieve it!