ASG Partners' interview with David Drews, CPA, CFA, Client Manager and Managing Director at Cornerstone Advisors
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Cornerstone Advisors, founded in 1984, provides portfolio design, construction & management services, family office services and financial counsel to wealthy individuals, families and organizations. The privately held firm is headquartered in Bellevue, Washington and has 45 employees. For more information about Cornerstone Advisors, visit Cornerstone's web site.
How can owners of privately held companies determine “how much is enough” for retirement to enable them to properly time their sale?
What's my business worth? That's a fair question asked by many an entrepreneur, and it's critical if you are raising money or selling a business. There are a number of reasons why you might need an objective and accurate assessment of your business. But of all the factors and methods used when setting a price for your business – from valuing tangible and intangible business assets, to industry and market comparables, to structuring the terms of payment – to name a few - none is more important than finding a value that matches your personal long term financial objectives.
A successful sale and the creation of a cash windfall is a major transition in your life, and the lives of your family. How can you structure your company to maximize your personal fortune? Does your exit strategy consider how to transfer wealth to family members? Such questions focus on financial planning, insurance, taxes, estate planning, investment management and the emotional consequences of a cash windfall.
From the outset, it’s important to note that you – the business owner – may have a hard time deciding objectively how much your business is worth. Business owners have a personal and emotional stake in their companies. So, the real question you need to have answered should not be “How much is my business worth?” but instead, “Is the price I get enough to support my future retirement income needs?”
So, to answer “How much is enough?”, you can find out what your “Cash Windfall” should be by asking yourself these three questions;
1. How much money do I need to support my family in retirement? This answer depends on your monthly expenses, retirement objectives, and how many years you expect to be retired. In general, we have found that our clients’ expenses continue to stay the same, if not increase slightly in retirement. Sure, you may decide to pay off your mortgage, but you will also have more free time on your hands to travel, buy that boat or vacation home you’ve been dreaming of, or spend more time with family or on the golf course.
As a good ballpark estimate, we recommend that our clients think about replacing 80% of their current salary with income that they could derive from an investment portfolio - more if you expect to pay for your own health insurance in retirement or you don’t have any other savings - and less if your income previously was far in excess of your needs.
While forecasting the number of years you’ll be retired is less precise, you should assume that you’ll live until you are 90 years old…though with advances in medicine, it’s possible that you could live longer! For instance, if your current annual salary is $200,000, and you are 50 years old, you will need at a minimum an investment lump sum portfolio of $5,000,000 invested at 4% net annualized real return to replace your current salary for each of the next 40 years. You also need to account for inflation and taxes, so in this example, your after-tax portfolio target return would need to be 8-9%.
2. What amount of risk am I willing to take with my cash windfall? The answer to this question will determine how much of your portfolio should be invested in (higher risk) growth-oriented investments vs. (lower risk) income-generating investments. Our clients’ portfolios are built based on their need for current income and their ability to withstand volatility of principal. However, given the certainty of future inflation, we recommend that our retired clients have at least some allocation to growth-oriented investments in their portfolio so that their income continues to grow in retirement to keep pace with future price increases over their long investment time horizon.
3. If my cash windfall is capable of generating enough income for my annual expenses, how much more do I need to support my estate planning gifts to family and charity? This answer depends in part on the size of your cash windfall from the sale of your business. If your ultimate selling price yields an amount far in excess of the windfall amount needed to generate sufficient sustainable income to cover your annual expenses, you are in an enviable position to begin considering accelerating gifting to family or charity, increasing your annual spending or even modifying your portfolio to increase or decrease the variability of its return.