Over the years, we've found that the most effective way to describe the goal-setting process to owners is to separate exit goals into three categories.
- Foundational: What must you attain before exiting or losing control of the business?
- Universal: What do you (and almost all other owners) want to achieve upon exiting?
- Aspirational: What aspirations do you have for yourself and your business, as and after you exit?
This article describes the one goal—the foundational goal—that must be attained if an owner is to exit successfully: financial independence.
The Foundational Goal: Financial Independence
The acid test for every Exit Plan—regardless of which Exit Path an owner chooses—is financial independence for the owner no later than the date on which the owner transfers control of his or her company. Only owners who achieve financial independence when they leave their companies can be said to have successfully exited their businesses.
If advisors doubt the absolute importance of financial independence, they should ask owners three questions:
- Are you willing to exit the business, and transfer ownership and control without assurance of financial independence? (If the owner's answer is that financial independence is a condition precedent to exiting the business, then having it is not just a goal: It is a requirement of exiting.)
- What amount of annual income (pre-tax) do you need post-exit?
- Is it equally critical that your family receive this level of income if you die before your planned exit date?
Financial Needs vs. Financial Wishes
Advisors must be careful to distinguish between how much money (as expressed as an annual income amount) the owner needs upon exiting and how much income the owner wishes or wants. Financial need is a prerequisite of exiting.
Seldom is an owner's financial need subject to downward adjustment, but owners' wishes regarding the amount of financial resources they want are always subject to revision.
Setting the Foundational Goal
How do owners determine how much income they need as and after they exit? As advisors work with owners to fix this number, we suggest that they be precise, accurate, and realistic.
In many facets of Exit Planning, absolute precision is not necessary because it's possible to make adjustments as circumstances change. Determining the financial independence goals is not one of those areas. Only owners with critical health issues, total burnout, or doing business in a rapidly dying business niche (think Blockbuster Video or instant print shops) should consider leaving before they attain their financial independence goal.
Determining how much income an owner and his or her spouse will need for the rest of their lives is not based on what they think they will need. It's based on what the planning process determines they will need.
Research shows that retirees continue to spend 70–85% of their pre-retirement spending, and some experts recommend that boomers aim "for a 100 percent replacement rate instead." These experts point to the costly activities that boomers are undertaking during retirement and the cost of health care.
The experience of many Exit Planning Advisors reflects that research. Successful owners generally do not decrease their spending, especially in the first years of retirement. In fact, they often add second homes, world travel, and new business start-ups to their existing expenses. The cost of health care is impossible to foresee, but not impossible to anticipate and plan for how long the owner and spouse might live. As we age, it is fair to anticipate that health care and related expenses will be significant.
Attaining financial independence is a prerequisite of a successful exit, yet we find that many advisors leave it up to the owner to figure out how much income they will need after they exit their business. Usually, this is a mistake.
Most owners do not have the capability to determine their lifetime financial independence needs, and most advisors do not have the training, experience, or desire to help owners determine their financial independence needs precisely, accurately and realistically. That's a real problem.
The solution, however, is simple: Encourage owners to engage an experienced financial planner to help them.
A financial planner can ascertain:
- The owner's financial independence needs.
- The likely income the owner's non-business investments (projected to exist at the owner's exit date) can generate.
- The rate at which the owner will use investment assets post-exit.
Advisors who aren't financial planners might be thinking, "So, what's my role here?"
Advisors' primary role is to show an owner why establishing financial goals that are precise, accurate, and realistic is critically important. Their next job, as skilled Exit Planning Advisors, is one they will perform throughout the Exit Planning Process: bring the right advisor to the owner's planning table at the right time. In the case of setting financial goals, that means helping clients engage a financial planner who has experience working with entrepreneurs.
Ready, Fire, Aim
In this aspect of Exit Planning, the advisor's role may seem rather insignificant, but it is not. Advisors assure that their clients don't do what entrepreneurs are so good at doing: taking action without sufficient forethought. They ensure that every future Exit Planning action leads to the owner's financial independence. If advisors don't encourage and direct their clients to set a realistic, accurate, and precise financial goal, no one else will, and it just won't happen.