In the last post , we argued that assumption-based Exit Planning was a pointless exercise that generally ends in disaster, preventing owners from exiting their businesses in style. Unless owners can leave their businesses when they want, for the money they need, and to the person they choose, they will probably fail to live the post-business lives they desire and deserve.Today, we will delve deeper to three basic questions and their fact-based answers, which form the foundation of every solid Exit Plan. We will cover Questions 2–3 in this post.
“All We Want Are the Facts” Exit Planning Questionnaire
What amount of annual, pre-tax post-exit income will you need after you exit? What is the joint life expectancy of you and your spouse? What is an appropriate withdrawal rate from your post-exit investment portfolio? What is your business worth? At what rate do you expect your cash flow and business value to grow? What will the net proceeds be from the sale of your business?As we did for
the first question, let’s look at the common assumptions owners make when answering these questions, which facts are required to answer them, and who on your
Advisor Team can help.
Question 2: What is the joint life expectancy of you and your spouse?
“I estimate my life expectancy (or the joint life expectancy of my spouse and me) to be ________ years.”
Common Assumptions : Many owners figure that they will live about as long as their parents did, on average. This is a dangerously imperfect method, because it flies in the face of facts and statistics, and doesn’t accurately examine how long business owners and their spouses are likely to live.
All We Want Are the Facts : Your business-owner clients should answer based, at a minimum, on general mortality statistics.
Accurate Information Source: Unless a member of your Advisor Team is also a medical doctor, there’s no particular advisor that can give sound advice on how long a business-owner client will live. However, you should encourage your clients to use
this calculator or any calculator based on the Social Security Period Life Table 2000 to determine their likely life spans based on evidence.Additionally, consider this information:A husband and wife are both 65-year-old non-smokers who have normal blood pressure. They consume two or fewer alcoholic drinks a day and engage in frequent exercise. Statistically, there is a 50% likelihood of at least one spouse living to age 98 and a 25% chance of one living beyond age 101.While life span doesn’t necessarily affect how much owners will spend on an annual basis, it does affect how much they will spend over a lifetime and how much capital they will need to fund that total amount. We are not suggesting that your clients need to prefund their great-, great-, great-grandchildren’s college education, but we are suggesting that health care advances and maintaining a healthier lifestyle than the average American will likely extend your clients’ life spans beyond their expectations. Remember, with increased life span and age come increased expenses.
Question 3. What is an appropriate withdrawal rate from your post-exit investment portfolio?
“I expect to withdraw money from my investment portfolio at the rate of ________% per year.”
Common Assumptions : Most owners believe that 7 or 8% is a realistic amount to take out per year. However, many experienced financial planners and the financial-planning industry say that that number is far too high.
All We Want Are the Facts : When owners overestimate the rate of return on their income-producing assets, they lower their estimates of the total proceeds they need from the sale (or transfer) of their business ownership. This can lead them to decide to exit too soon, which almost always leads to them running out of money during their lifetimes or being forced to reduce their desired lifestyle.It’s easy for your clients to confuse the investment return they expect on their investments with the withdrawal rate from those investments. The financial industry has long used a 4% withdrawal rate as a reasonably safe rate. This rate partially accounts for typical upswings and downturns in annual investment returns. However, some advisors have recently begun challenging that rate as too high, recommending even lower rates, such as 3%. The withdrawal rate is calculated by determining which amount—as a percentage of the assets available on the owner’s targeted exit date, adjusting for inflation—will be sustainable for the owner’s and his or her spouse’s lifetimes.
Source of Accurate Information : Your Advisor Team’s financial planner can fine-tune your client’s withdrawal rate based on age, health, Social Security benefits, and other factors. It makes sense to get expert financial-planning advice at the outset of Exit Planning.In our next post, we will finish our fact finding by answering Questions 4–6.
