What’s Better: Cash or Cashflow?

Have you ever worked through the math of selling versus keeping a business?

Have you ever worked through the math of selling versus keeping a business?

The conversation with clients goes something like this:

Business Owner: Hey Paul, I think I want to escape from this business – How much do you think I could sell it for?

Paul: Valuations can get a little complicated, but on the back of the napkin we could take the annual cashflow and apply an average earnings multiple to get a value:

Annual cashflow = $100,000 x Earnings Multiple of 5X = Valuation of $500,000.

Business Owner: So, $100,000 per year of cashflow could be exchanged for $500,000 of cash?

Paul: Roughly and smoothly – yes. But there are a couple other factors to consider. You may have to pay capital gains tax on the sale – so after tax that might only be $400,000.

Business Owner: How much could I get in annual cashflow from the $400,000?

Paul: That’s really a question for your investment advisor, but my conservative portfolio returns about 4 to 5% these days.

Business Owner: So my cashflow after selling the business would be $400,000 x 4.5% = $18,000 per year?

Paul: Yes, but there is one other big factor to consider – the perks of business ownership. Does the business currently pay your cell phone, provide you a car, provide some promotion meals and clothing or any other perks?

Business Owner: Yes – that something I really don’t want to give up. Do you mean if I sell my business, then I have to pay my cell phone bill out of the $18,000 a year?

Business Owner – after pondering the choice…: So in summary, selling my business will turn $100,000 cashflow into $400,000 cash – which then turns into $18,000 a year cashflow with no perks!

Paul: It’s a back the napkin calculation, but that’s roughly, smoothly the deal.

Business Owner: I think I will keep it!

Paul: Good idea. Now there are some important things you might want to consider as a business owner:

  1. Have a “stash the cash” plan for the good years of ownership. This builds your investments outside the business and will grow the investment income cashflows over the long-term.
  2. Work on replacing yourself in the business, so you can have some freedom from the business, keep the cashflow and the perks and still enjoy your life too.
  3. There is an exit strategy choice that might allow you to keep some perks and some cashflow as your transition out – sell to the next generation or sell to key employees.

Business Owner: Yeah, lots to think about. How soon should I start this type of planning?

Paul: It’s kind of like planting a tree. There are only two good times to plant a tree. One good time to plant it is today, the other good time was 25 years ago.

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