Skydiving Into Retirement

Geronimo! 

I have been skydiving twice. Both times in Lompoc, CA. The Pacific Ocean spread out to the west, and a valley floor of colorful flowers below. I jumped out of an airplane at 18,000 feet and it was exhilarating. I loved it. Tom Petty’s Free Falling was the background music on the video DVD I ordered for $30. It was awesome.

For those that enjoy thrills, skydiving is a must. For those seeking to sell their business and retire, I do not recommend skydiving into retirement. What do I mean?

Well, when I jumped out of the airplane I yelled, “Geronimo!” It seemed appropriate. Geronimo is a term that has become synonymous with fear, risk, exhilaration, and danger. It was the nickname of the legendary Chiricahua Apache “Goyahkla” (“The One Who Yawns”).  

While the origin of the nickname remains a mystery, many believe it originated from frightened Mexican soldiers calling on the Catholic St. Jerome for protection when facing the feared warrior in battle. In modern parlance, we scream the word prior to doing something dangerous, risky, exhilarating and daring. Skydiving certainly qualifies as dangerous, risky, exhilarating and daring. 

Entering retirement, however, should not be dangerous, risky, or daring, although perhaps exhilarating. Business owners ready to sell their business without doing any exit planning are essentially skydiving. If your business is a major part of your retirement and you list the business for sale with no planning on the front end, then you are yelling “Geronimo!” as you jump out of an airplane. You are embarking on a risky endeavor.

The main difference between you and I is I had a parachute. 

When To Start Planning: How Far Out Is Too Far?

I tell folks the ideal business owner client for me is one that is two to three years away from retiring and wanting to plan their exit out of their business. The truth is, though, you can never be too far out in planning. Who cares if you just purchased or started your business? Go ahead and start with the end in mind. 

I believe those wanting to retire need to start planning at least three years out. Five is better in certain situations. If you are a business owner,  this means preparing your business to sell. 

In small business sales, mergers and acquisitions, inherent conflicts exist between running the business (to make and provide a living) and making a business saleable (to maximize value). These conflicts lurk around every corner. For example:

• You pay yourself K-1 distributions when running the business. That’s good. But that does not help maximize your valuation when it’s time to sell. Inherent conflict. 
• Say you are the daily operator. Those looking for absentee management will likely not be interested in purchasing your business—danged if you do. Say you are not the daily operator and have management in place. The buyer may want to be the operator and fire the employee post-closing—danged if you don’t. Inherent conflict. 
• In price allocation what is good for the buyer is often bad for the seller. Inherent conflict.

Some of the changes necessary to address these inherent conflicts and move the business towards salability take time to implement. How long? Consider the following examples of the wise, the prudent, and the foolish.

The Wise: Planning Two to Three Years in Advance of Sale

A few years back I met with a business owner off a referral from my financial advisor. She was his client as well. My advisor said she was ready to retire and wanted to talk about selling her business. The business was the final piece of her retirement puzzle, so there was a particular amount she needed.

I sat down with her and we began analyzing her business. She was ready to sell but understood the business might not be. Without getting too far into the weeds, I did a financial recast. This determines the Seller’s Discretionary Earnings (SDE) of the business, which is used in pricing the business. We did this together, and upon completion she was shy of the value she needed. 

We were using SDE as the pricing metric. I noticed at first glance that she did not pay herself a salary through payroll. Often this is reflected on tax returns under “Officer Compensation”  or something similar. Upon further investigation, she revealed she took K-1 distributions per her CPA’s advice. This did not surprise me as it's the right thing to do to save on taxes…when running the business. 

However, a big component of SDE is the owner salary, which can only count as part of the SDE when it is run through payroll as a W2 Salary. In this instance, if she paid herself a salary through the business of $50,000 then we would be able to justify the value she needed based on the new SDE and the multiple being used. I pointed this out and she understood. 

We visited with her CPA, who was on board with the plan, and then she waited 24 months to come back and list the business. During this time, she implemented the salary, along with some other things we discussed which were unique to her business and situation. Mainly, eliminate the “outside” expenses and make the bottom line a bit bigger. And take everything to the bottom line, i.e., no hidden cash drawers. 

She was wise to listen and implement the changes. Within those 24 months we listed the business above the price she needed, in short time got full price for the business, and she sailed off into retirement with peace of mind. This occurred because she planned two to three years in advance and was patient to implement the changes needed. 

The Prudent: Planning Five Years in Advance of Sale

I have a current client who had a heart attack five years ago. Prior to that, he was his business: He was the face of the business, he answered every call, he knew every job; he did everything. Therefore, his business came to a screeching halt when he had his heart attack.

He had a great business but knew he had to change things. It had always been his goal to sell his business when he was ready to retire. He started with the end in mind. But somewhere along the way he became one with the business—and this can make it hard to sell.

From that moment to the moment we listed the business he had been preparing it to sell. Management is in place, though he, too, is involved. His involvement is not hard to replace, however. We listed his business about 15 months ago. We have had a lot of activity on it. Five years ago, he began planning for the sale of his business, and when we do sell it he will get more than what he needs to comfortably retire. 

The definition of prudent is acting with or showing care and thought for the future.

In a nutshell, that is exit planning.

The Foolish: No Planning

Consider this 2023 survey from the International Business Brokers Association:

A staggering 90% of small business owners have no formal retirement planning prior to listing their business. This is even more staggering when one considers that retirement is the number one reason—by a long shot—for selling a business. Anywhere from 39% to 68% of sellers list retirement as the reason why they want to sell. 

Yet, despite the ever-growing numbers of retirees, business owners across the board favor the Geronimo method of exit planning and neglect preparing for this momentous, life-changing event. This is foolish, if I may be so blunt.

The primary risk with the Geronimo method is the value of the business is not enough to meet the seller’s needs to complete their retirement package. On average, 70% to 90% of a small business owners’ net worth is tied up with their business. It is an integral part of the overall retirement package. The seller must get a certain amount for the sale of the business, or the seller is unable to retire. Exit planning two to three years (or more) in advance ensures no surprises when it comes time to sell and retire. 

Conclusion

As a business owner, give yourself two to three years (or more!) to plan your exit. Having two to three years to bolster your cash flow (SDE) and making the business more flexible for various types of buyers are two areas you can control directly and both add significant value to your business. 

If you already do both of those, look for ways to improve margins, trim fat, bolster the bottom line and increase the cash flow of the business. Sometimes it is as simple as:

1. REPORT ALL REVENUE. No more secret cash drawers. 
2. Trim the fat! Even saving 0.25% in one area of the business adds up. A general rule is one dollar saved equals three dollars added to value. 
3. Avoid expenses, campaigns, new endeavors, etc. that tighten margins and/or hurt SDE. 
4. Adhere to the George Costanza Rule: Go out on a high note! Don’t sell when things are down. 

Just those basic practices and principles alone can add tens of thousands of dollars, if not more, to the value of your business. I tell owners to go visit with a firm two to three years out from selling. A good firm will form a relationship with you knowing you could be a potential future client. A great firm will give you tips on how to increase the value of your business in the next two to three years to get what you need. 

Preparing on the front end by having a strategic exit plan in place will protect your financial legacy. You will maximize your business’ value, secure your financial future, and enter retirement with peace of mind. 

Otherwise, you are just screaming “Geronimo!” without a parachute. 

Good luck.