In our last article, we shared the most effective way to engage owners in Exit Planning: Use accurate data to dispel owners’ common misperceptions about their Asset Gaps. Until owners face accurate facts, they often incorrectly assume they have sufficient resources to exit whenever they wish.
We also argued that replacing an owner’s assumptions with facts is a job for professional experts. We described the importance of quantifying the resources an owner needs to attain his or her goals. Typically, this analysis uncovers a measurable Asset Gap. That gap must be filled with additional income-producing assets to ensure the owner’s financial security post-exit. Once we’ve determined the size of a gap, bridging it becomes a primary focus for most owners and their advisors.
To see how properly assessing the gap provides the framework necessary to bridge it, let’s return to Carl, a business owner, and Larry, his advisor.
It had been a few weeks since Carl, the owner of Foley Steel, had met with his advisor, Larry, about exiting. Over the course of those weeks, the expert advisors Larry recruited dispelled Carl’s assumptions about his current and needed resources. Specifically:
- The business appraiser estimated a likely sale price of $2 million.
- The CPA and M&A advisor estimated net proceeds of $1.3 million, which differed from Carl’s original estimate of $2.5 million in net proceeds.
- Given Carl’s $1.5 million investment portfolio, the financial planner suggested a withdrawal rate of 4% and confirmed Carl’s annual income need of $300,000. This differed from Carl’s original estimate of a 7–8% withdrawal rate.
Once they had clarified Carl’s resources, Larry said, “Carl we now know your starting point: Your net assets are about $3 million. We know you need $7 million to exit on your terms. Your gap is $4 million. We can now design an Exit Plan to close the gap and enable you to leave your business on your terms. As I understand your terms, you want to leave in no more than seven years with $7 million in the bank. Have I got that right?”
“Yes,” Carl responded. “Let’s get started.”
How Owners Benefit From Quantifying the Asset Gap
Owners who work with Exit Planning Advisors who show them the actual gap between where they are and where they want to be when they exit benefit enormously. First, before they subject their assumptions to the scrutiny of professional experts, owners articulate their goals—at least their foundational goal of post-exit financial security. Second, they exit the “reality distortion field” that traps so many owners in a state of blissful but unfounded complacency. Owners who remain there are unlikely to ever meet their objectives or experience a successful business exit. That’s sad because for most owners, the business exit is the most significant financial transaction of their lives.
The exercise of quantifying (a) existing resources and (b) resources needed to achieve the owner’s goals enables owners to see the gap (if any) between those two amounts. We call this exercise a Gap Analysis.
How Advisors Benefit From Quantifying the Asset Gap
Advisors experience three distinct benefits from performing a Gap Analysis for their business-owning clients:
- Increased Client Engagement: Advisors who understand how to walk owners through a Gap Analysis and use professional experts in the process engage owners far more often—in both Exit Planning and in their core practices—than advisors who rely on their own powers of persuasion.
- A Proven Process and Timeline: Accurately assessing the distance to an owner’s goal gives owners, management teams, and advisors a framework within which to develop and execute strategies to close the distance. This increases the advisor’s appeal, since most business owners crave a process that helps them achieve their goals.
- Greater Trust: Advisors use the Gap Analysis and subsequent timeline to create actionable Exit Plans for their clients. Using the results of the Gap Analysis, Advisors make recommendations, and assign deadlines and responsibilities. In doing so, they build trust with business owners because owners can physically see what they need to do to exit successfully, rather than imagine it.
The Asset Gap Establishes the Framework for Carl’s Exit Plan
Let’s return to Carl and his Exit Planning. At his company’s current rate of growth, Carl will never be able to close his gap. To close his Asset Gap of $4 million within seven years, the business will need to double in value and cash flow. How will Carl and his advisors make this happen?
As we’ll see in subsequent articles, growing and preserving business value and cash flow is the next logical step for most owners. Unfortunately, growing value, especially on a timetable, doesn’t just happen without effort. Carl will have to augment his rudimentary management team and hire experienced professional advisors.
If Foley Steel’s cash flow and value are to increase at the rate necessary for Carl to exit in seven years, there has to be action! Some actions will be the responsibility of Carl’s advisors, some will be Carl’s responsibility as an owner, and some will belong to Carl’s management team.
The team of advisors that Larry brings together will create a list of cash flow- and value-building actions, each designed to progressively bridge Carl’s Asset Gap. They’ll describe each action in Carl’s Exit Plan, assign each action to a responsible party, and establish timetables for each action that include checkpoints to measure progress and deadlines. If all goes according to plan, Carl will exit his business in seven years while meeting his financial and values-based aspirations. If the plan goes awry, the Exit Plan will be flexible enough for Carl to change or lengthen his course.
Understanding the Gap Is the Catalyst for Owner Action
Although discovering their Asset Gap can be jarring to owners, it’s almost always a long-term positive. When owners learn that the distance to their financial goal is much farther than they anticipated, most are highly motivated to devote their attention to increasing business value and cash flow. Contrast that energy with the blissful ignorance that characterizes most owners who mistakenly assume that their financial goals are within easy reach: When ignorance is bliss, there’s no reason to act.
For the few owners who find that their assumptions are correct and that the gap separating them from their financial goal is small or non-existent, that information is power. They can focus directly on other aspects of the Exit Planning Process, including choosing the best Exit Path (e.g., sale to a third party, transfer to a key employee or co-owner) and perhaps the best location for their post-exit vacation homes.
- Providing a Gap Analysis that owners know is based on reality and their exit timing is key to getting owners to act and stay the course.
- The gap between what owners have and what they need to live the post-exit lives they desire is far wider than most owners imagine.
- Advisors usually spend considerable time and effort on this aspect of Exit Planning. Coordination of this effort is necessary.