You have a business that is doing well and paying the bills. Maybe it has put one or two children through college. The kids are working, maybe on the Mainland, and not interested in taking over the family business. Now what?
Best to think about this situation several years before you need to make any decisions. Some call it an “exit strategy,” some call it “retirement,” while others say, “I’ll never retire.”
Regardless of what you call these plans, it is important to receive the greatest value possible for your business to be comfortable in your golden years.
A little simplistically, there are basically two ways to manage a business. One is to increase or maximize cash flow to live comfortably and provide for yourself and your family. The other way to manage a business is to take steps to increase the value of the business to maximize its sales price. Before I describe both approaches, let me say it’s difficult to do both at once.
Maximizing cash flow to maintain a standard of living means minimizing taxes and having the company pay for as many owner or employee expenses as legally allowed. Many small businesses become obsessive about these efforts, but there are risks. The IRS may not agree with some expenses being covered, especially if the owners personally benefit from those expenses. Naturally, this approach leads to lower net income, lower taxes and more immediate benefit to the business owners.
Maximizing value means generating higher net income, which increases the value of the company. Drilling down into a formal business valuation is beyond the scope of this article, but many times a starting point for valuing a business is either by sales levels, net income or cash flow; commonly all three are used to establish high, low and mid-point values. Maximizing sales and net income does not always lead to lower taxes and better cash flow, which is why it is challenging to do both simultaneously.
Knowing how long you need to live off the cash flows of the business before selling allows you time to plan. Once a proposed sales date is set, hopefully several years in advance, the owner can begin the process of increasing sales and profits to justify a higher sales price. Sometimes much higher.