We have written all around the idea of the owner selling their company, preparing their company for sale, accounting preparation, valuing their company, the preferred type of buyer, etc. Let’s be more direct. Can the owner afford to sell their company? This question sounds like a contradiction in terms, but we will dig into it further to clarify the play on words.
Many privately-held companies are operated as a “lifestyle” business for the benefit of the owner, i.e., they are operated to establish and maintain a standard of living for the owner. Specifically, the company employs many immediate and extended family members both at market and above market rates of compensation and benefits.
The Company pays personal expenses including meals, travel, etc. The company pays for tickets for local entertainment. The company pays for multiple cars and the associated expenses. The company pays for country club(s) that are used both for business and personal reasons. The owner’s philanthropic activities are paid by the company. In a nutshell, the company is operated to generate current cash flow for the benefit of the owner and their family. Many companies have scale to support both the lifestyle of the owner and to continue to invest in the company; however, many do not have the scale to support both needs. The lifestyle/investment decision is personal to the owner; however, if the company does not have the resources to support both needs, there may be consequences to the “lifestyle decision” as the owner considers the sale of their company.
Let’s start by summing the “lifestyle costs” associated with operating the company in this fashion. Let’s then compare a) the estimated net proceeds from the sale of the company with b) the lifestyle costs.
Based on the net proceeds and the total lifestyle costs, can the owner maintain their lifestyle post sale?
Of course there are a number of critical assumptions to answer this question. What is the age of the owner and their spouse, i.e., how many years do the net proceeds need to last? What is the health of the owner, their spouse, and other family members in their care including special needs family members and parents in their care?
Does the owner have liquid assets (e.g., stocks, bonds, mutual funds, cash and equivalents) or income producing assets (e.g., rental real estate) outside of the value of the company that can supplement the net proceeds from the sale of their company? How aggressively does the owner need to invest their liquid assets post sale to maintain their lifestyle?
What is the interest rate environment? In the most conservative scenario, if the net proceeds from the sale together with external liquid assets were invested only in cash and equivalents, would these assets generate sufficient interest income for the owner to maintain their lifestyle? When interest rates are 1%-2%, the answer is quite different than when interest rates are 4%-5%. Based on the answers to the foregoing questions, the owner may or may not be able to afford to sell their company and maintain their lifestyle.
As discussed in prior emails,
the owner needs to understand the cost of their lifestyle and the expected net proceeds from the sale of their company as they consider the sale of their company. Otherwise, they may be disappointed at the conclusion of the sale or, worse, realize several years later that they have insufficient resources to maintain their lifestyle for the remainder of their life.
Another consequence of operating a lifestyle business is the impact on the value of the company. In order to maintain a lifestyle, the owner may choose to defer investing in the company in areas such hiring new employees, providing continuing education for employees, seeking new customers, investing in new equipment, and maintaining existing equipment. Lack of investment is tantamount to disinvestment in the company. As this process continues over many years, the value of the company will decrease rather than increase, which, circularly, makes it harder for the owner to sell their company at a price that will enable the owner to maintain their lifestyle post sale.
In conclusion, a lifestyle company does just that – generates a great lifestyle for the owner and their family. However, after managing the company in this fashion for many years, can the owner sell their company at a price, which, when combined with non-company resources, will enable the owner to retire and maintain their lifestyle, or in other words, can the owner afford to sell their company?
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