Editor’s note: This is the first article in a two-part series. The second article will explain how business owners can work out their wealth gap in five minutes.
In 2016, we had a client very close to signing a letter of intent to sell their business for $6 million. It seems like a big number, but what was obvious to us, as their financial planner, was that it wasn’t enough. I’m not saying it wasn’t a fair offer. But after taxes and repaying the investment bank, it wasn’t enough money to replace their income and pay for their lifestyle.
There are a lot of important numbers when it comes to selling your business. Perhaps the biggest driver of valuation is growth, but this is something different. What I’m talking about is the number that you need to know, to know you won’t run out of money beyond the sale. This is the “wealth gap.”
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
The wealth gap and your retirement
The wealth gap is the difference between your current assets and the amount you would need to support your lifestyle. For a business owner, it’s what you need to get from selling your business. We were advising a couple who needed about $25,000 a month, or $300,000 a year, to support their lifestyle.
As their planner, we knew they needed about $9.5 million in gross (pre-tax) liquid assets to support this number. They had about $1 million saved in their 401(k)s. Therefore, they needed to get $8.5 million from the sale of their business if they planned to stop working beyond the transition period, which they did. That $8.5 million is the wealth gap.
We relied on financial planning to come to the total number they needed to fund their lifestyle. That allowed us to factor in things like taxes, future income from Social Security and historic market volatility. You can access a free version of the planning tool we use.
In the next article in this series, I’ll cover a back-of-the-envelope way to calculate your wealth gap.
Closing the gap
One major challenge in all of this is that it’s very tough to know what your business will sell for. As the owner of a wealth management business, I can look at the industry and see the biggest five to 10 companies that also serve my client niche and figure that one of them will buy me.
According to Woodbridge International, an investment bank for small to midsize businesses, of the 25 businesses they sold in 2024, 23 did not know the buyer prior to the transaction. This is the importance of having a good investment bank. Sometimes the wealth gap can be closed just by finding the right buyer.
The other end of the spectrum can be more obvious: Those who are not close. Once again, I’ll use myself as an example.
I was a partner at a wealth management firm that sold. I now own my firm, Exit 59 Advisory. Even with the previous sale, my business is not worth my wealth gap. Add to that, I have a 6-year-old, a 2-year-old and possibly a newborn by the time this is published. My runway is long. For people in my situation, the wealth gap is not all that helpful. You need to focus on a different metric: the value gap.
I’d like to take credit for what happened next to the client who backed out of their initial sale, but the reality was that they did the hard work to close the gap. In the next four years, they drove down client acquisition cost by introducing other marketing channels, increasing revenue through those same channels and increasing margins through the use of technology.
In 2024, they sold the business for about 10 times that initial offer. Sometimes it’s finding the right buyer. Sometimes it’s driving up the value of the business. Often, it’s both.
In this case, they way overshot their wealth gap. They much preferred that to the stress of cutting it close.
Related Content
-
Is Your IRA Protected in Bankruptcy?Can creditors take some or part of your IRA funds if you file for bankruptcy? Learn more about the federal protections that exist and to what extent they protect your IRAs.
-
What Retirees Need to Know About TaxesTake steps to avoid a surprise tax bill and underpayment penalties.
-
My Husband Is Terrible With Money. I Worry He'll Quickly Spend Our $1.3 Million Nest Egg. How can I Ever Retire?We asked expert financial advisers and therapists to weigh in.
-
Roth Conversion in a Down Market: Is it Right For You?Facing a future tax hit on your retirement savings? A Roth conversion may be a way to lower the taxes you owe.
-
Tax Advantages of Oil and Gas Investments: What You Need to KnowTax incentives allow for deductions and potential tax-free earnings — benefits accessible only to accredited investors in small producer projects.
-
Charitable Contributions: Five Frequently Asked QuestionsMake the most of your good intentions by understanding the ins and outs of charitable giving. A good starting point is knowing what's deductible and what isn't.
-
Financial Leverage, Part Two: Don't Say We Didn't Warn YouA lesson in how highly leveraged investments can benefit the first movers and crush the next round of buyers.
-
Taxes in Retirement: What ESOP Participants Need to KnowMost Employee Stock Ownership Plans (ESOP) participants transfer company stock to an IRA starting around age 55, so taxes on that money have been deferred.
