The financial newspapers and entrepreneur magazines paint their pages with multi-million dollar exits of “super-smart” entrepreneurs. The dirty details of the sale rarely hit the page because reality does not sell newspapers and we all want to believe it can happen to us. The truth is the majority of exits don’t achieve the Point of Independence, which is place where the worry about money disappears forever. Too many founders find out the hard way and often times it is too late to correct. Here are the pitfalls to help you avoid “exit failure”.
Most entrepreneurs think they can do it again. As journalist, best selling author and staff writer of The New Yorker Malcolm Gladwell discusses in his book Outliers: The Story of Success, success is the culmination of being at the right place, right time, right vision, and hard work. Only one of these things we can control – hard work. The iPod was not even close to being the first portable mp3 player. Perfect vision at the wrong time equals failure.
It is estimated that only four percent of business scale to $1 million dollars in revenue. If an entrepreneur with a successful exit is five times more likely than his peers to do it again, his or her odds of the follow up success are 0.8%. Despite the odds, most entrepreneurs are confident they can do it again. The reality is most of us only have one successful exit so we have to get it right the first time.
When you sell your business, you switch from investing in yourself to investing in others, you become a lender of capital. Lenders get paid less than owners. But let’s assume you are a masterful investor and earn a guaranteed 10 percent per year with your new wealth; the example below will help paint the divide.
Let’s assume your company delivers $500,000 of before tax income. At 5x EBIT, the value of the company to a stranger is $2.5 million. If you started the company from scratch, your basis is zero which makes the sale 100 percent taxable gain. You really sold it for $1.75 million because your silent partner, the IRS, takes their share. Your new paycheck at 10 percent guaranteed return is $175,000 — before taxes. This hypothetical business owner just took a $325,000 pay cut when he or she sold the business.
Since we know the odds of the second success are miniscule, treat your first exit like it will be your only exit. And make sure the sales price achieves your Point of Independence. If the exit cannot set you and your family free, there is nothing wrong with milking that cash cow you created forever.
Russell Holcombe is President of Atlanta-based wealth management firm Holcombe Financial and author of the award-winning book You Should Only Have to Get Rich Once. Holcombe earned his Masters in Taxation from Georgia State University, his BBA in Finance from Southern Methodist University, and carries the CERTIFIED FINANCIAL PLANNER™ designation.