Saturday, December 1, 2012

If You Can't Say "Yes", You Don't Have Enough

Can you really afford to sell your business? Can you afford to give it to your kids? Are you financially OK if your business vanishes?

In a recent Chief Executive Boards International meeting, a member was asked, "If your business went away tomorrow, would you have enough assets outside the business to last the rest of your life?" The member hesitated, stammered, and then another member made a profound statement, "If you can't say yes to that question right away, you don't have enough."

So, do you have enough? Do you know what "enough" is? If not, you have some serious homework to do, right away. So, how do you figure that out? Here are the steps:
  1. What are you spending now? Most people don't know. If you're in that group, here's a suggestion. Install some personal finance software -- click here for some choices.   I prefer Quicken because it directly interfaces to my bank. 
    This isn't about budgeting -- its just about tracking what you're spending now. I've been doing this since 1996, and we know exactly what our annual burn rate is, by expense category. It's been surprisingly stable, year after year. Hugely helpful to be confident in calculation of your "number".   Just take each check and each credit card bill and break it down into a couple of dozen expense categories (doesn't have to be GAAP). 
  2. Get all your assets and liabilities on a single balance sheet. Your personal finance software selection will give you a platform to do that.
  3. Apply the 4% rule to your liquid assets (not including home equity, household assets, etc.). You can find countless articles saying that somehow this is no longer valid. In fact, it's as good as it gets when forecasting uncertainty. Over a 20 or 30 year time horizon, you can afford to burn 4% of your net worth per year at the start, while giving yourself a "raise" each year to keep up with inflation. That has about a 90% chance of keeping you from running out of money before you run out of heartbeats.  The assumed investment mix in this is 60% stocks, 40% bonds, although a 40%/60% mix gets you essentially the same result. 
  4. If you have a real plan for cashing out of your business and an objective valuation to estimate those proceeds, you can apply the 4% rule to that amount, also.   Adjust for the possibility that it's your estate selling the business and discount accordingly for your absence. 
  5. Add in any other cash streams. Do you have rental income?  What can you earn from part-time work or consulting? You'll be amazed at how $50k or $100k/year in consulting income improves this picture. That's only 2 to 4 billable days a month. Do you have any pensions, royalties or other annuity-style income? Of course Social Security is included. You get an annual forecast from the SS Administration of what that cash stream may be worth.
  6. Do the math. Add the 4% withdrawal of your liquid assets and business sale proceeds to other cash streams and subtract your current burn rate of household expenses. Click here for a worksheet, borrowed from Lee Eisenberg's book, The NumberWhere are you?
If that answer is positive with a reasonable cushion - say, 25% to 50%, then you can confidently and immediately say "Yes" when someone asks "Do you have enough money to last you the rest of your life?" If you can't answer that with "Yes" right away, then you need a better plan. Either reduce the burn rate or figure out how you're going to earn, save and accumulate the assets necessary to give you the cushion you need. Part of that solution might be to just figure out how to accelerate the extraction of cash from your business.

Shortcut:  I just saw an article in Money Magazine, saying that for the average person with an ordinary asset base (stocks & bonds) a net worth of 10x-12x current income  (or current income necessary to support current lifestyle) would also be a good sufficiency test.   I ran that range on my own situation and it came out about dead even with the more technically correct 6-step approach above.   Try it for yourself. 

Escapingly simple, but surprisingly few business owners have this one nailed. Considering that when you and your spouse are 65, you have a better than 50% chance of either of you living to be 90, isn't it a good idea to figure out how you're going to be able to afford that next 25 years with minimal earned income?
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Terry Weaver

Chief Executive Boards International
Chief Executive Boards International: Freedom for business owners & CEOs -- Less Work, More Money, More Freedom to enjoy it

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