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Capital Ideas for Private Business

Business Ownership & Real Financial Freedom

The Buzz That Nobody Talks About

By Jay Carter, Principal
Charlotte Office, Corporate Finance Associates

My clients depend on me to provide sound advice when they’re considering business ownership. I ask them all the same simple question: “Why do you want to be a business owner?” They excitedly rattle off their list of reasons, which typically include:

  • "I want to be my own boss."
  • "I want to be accountable only to myself."
  • "I want to pursue a field about which I am passionate."
  • "I want to increase my income."
  • "I want to have a more flexible work schedule."
  • "I want to see the results of my own hard work."

There are variations on this list, but the principles are the same. However, for all but a very few of my clients, the single most important objective is one that almost always goes unstated (and even unrecognized) until late in their careers and that is Real Financial Freedom for themselves and their families.

I define Real Financial Freedom as “the freedom to spend the rest of your life doing whatever you choose, without having to worry about your financial security.” Real Financial Freedom is achieved when your diversified base of investment assets reaches your pre-determined target.

When compared to those most commonly stated goals of business owners, Real Financial Freedom takes the longest to achieve—but receives the least amount of attention from the owner. Real Financial Freedom is something that most business owners expect to happen if they work hard, but few make any conscious plans towards achieving.

Beware of The Brew

I see it time and time again; This intoxicating – and often fatal – brew which seduces business owners, particularly those who have built a successful business over many years. At a time when the owner should be awakening to a desire for Real Financial Freedom, his company’s revenues, profits, cash flow and his personal income have never been higher. All the years of hard work and personal sacrifice are paying off and the machine he has built is purring along like a Bentley.

The value of his business has grown to the point that he now believes he has achieved Real Financial Freedom. Can’t you see him? He wears a mantle of pure contentment and self assuredness. He wears polo shirts to the office more days than not, and he almost never wears socks anymore. His hair is getting on the long side. He’s gotten into the Brew.

In his impaired state, the owner has overlooked an important prerequisite for Real Financial Freedom: a diversified base of investment assets. Though his total net worth may have reached his target level, most of this remains concentrated in the value of the business. To aggravate matters, the business is also the owner’s primary source of income. Real Financial Freedom remains distant, but he is unconscious to this fact. What was supposed to be sweet freedom is actually a cruel illusion: He is certainly not free to do whatever he chooses for the rest of his life.

What Happened? Where Am I? – The Sobering Truth

Perhaps the best way to demonstrate where things go wrong is with an illustration. In this example the business owner and his financial advisors have determined that his Real Financial Freedom target is $10.1 million. That is, after taxes and transaction costs, he must end up with $10.1 million in diversified investment assets to meet his financial objectives. Working backwards, if we assume that taxes and transaction costs will be 25% of the company’s value and that the owner has no outside investment assets the resulting target company value is $13.5 million.

Research shows that other companies in his industry have sold recently for 5 times EBITDA (Earnings Before Interest Taxes Depreciation and Amortization). This company’s EBITDA will be $2.70 million in this, its 20th year, yielding a company value of $13.50 million.

The above simple chart is tracking the company’s performance, everything looks great for 20 years. Now, notice a “zig” in the EBITDA and Company Value lines in year 20. This zig reflects the impact of an unplanned, uncontrollable and unforeseen event that triggers a 25% drop in the company’s revenues (and EBITDA). This could be caused by almost anything: the weather, a product recall, a terrorist attack, interest rates, illness. There are MANY things beyond the owner’s control that can impact a business. Some of these events are positive, some negative. The negative ones, of course, are what we are concerned about.

After the zig, even if the company is lucky enough to recover and continues to grow at the historical rate, the value of the business does not reach the Real Financial Freedom target for six more years! This could have been avoided altogether if the owner had completed the last step towards Real Financial Freedom: creating liquidity through the sale or recapitalization of the business in order to facilitate diversification of his investment assets.

Remember that? This six year recovery period represents a lot of additional work, a lot of additional risk, and a lot of the remaining years of the owner’s life just to get back to his target level.

The lesson for the business owner is simply: accept that sooner or later, Real Financial Freedom will be your primary objective. Then all you need to do is:

  • With the help of a good advisor, establish your own financial target;
  • Recognize when you have reached your financial target;
  • Protect and preserve the value you have created by diversifying your net worth. This is accomplished through a well-planned and executed recapitalization or sale of your company.

Now you are ready to enjoy Real Financial Freedom!


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