In this installment, we’ll build on what was discussed in Part 1, “Business Exit and Succession Planning: What To Consider & Where To Start.” In this piece, we’ll dive deeper into one of the most critical components of your succession or exit plan: your gap analysis.
A gap analysis is a foundational necessity when planning for your business exit or succession because it helps to clearly define your financial needs once you hand over the reins or reduce your capacity (and income) in your business.
We’ll also address some common blind spots and share additional insights to help you plan more effectively. So, let’s begin by first assessing your potential financial needs.
Why You Need a Financial Needs Assessment
For business owners, a universal goal is to ensure financial security after stepping back from or exiting the business. Unlike traditional employees, business owners’ wealth is often tied up in the company itself, making financial planning a bit more complex. Beyond conventional savings and investments — like retirement accounts, investment portfolios and CDs — your business is a significant asset that can potentially generate ongoing revenue or be sold for a large sum.
A crucial part of exit planning is to verify that this asset, whether you’re selling the business outright or retaining a stake, meets your financial needs. This is where a gap analysis comes into play. It measures the gap between your current financial standing and where you need to be to achieve financial stability for retirement. This involves a thorough assessment of your business’s current value, projected growth and other assets.
What is a Gap Analysis and Why Does It Matter?
When it comes to planning your exit strategy, a gap analysis is a key tool to help you determine if your business and other financial assets can support your lifestyle once you step back. Essentially, you’re making sure your assumptions about your business’s worth, future growth and longevity of your assets are realistic.
Many business owners make critical mistakes by relying on inaccurate assumptions, such as:
- Overestimating the value of their business
- Misjudging the growth trajectory of their business
- Underestimating how long their income will need to last
- Overlooking the true expenses they’ll face in retirement, especially when some will not run through the business any longer
For instance, it’s common to assume your business will continue to grow steadily or that you can sell it for a certain price based on optimistic projections. However, market conditions can be unpredictable, and growth isn’t always linear.
This is why accurate data is crucial. A well-conducted gap analysis helps you assess if the future value of your business and assets will truly align with your financial needs after you exit. This careful planning ensures you make well-informed decisions rather than rely on hopeful but inaccurate predictions.
Common Misconceptions When Conducting a Gap Analysis
When you dive into a gap analysis, it’s easy to get caught up in certain pitfalls. Here are a few common misconceptions:
- Business Value: Many owners think their business is worth more than it actually is. The market value might be lower than expected.
- Projected Cash Flow: The income your business generates, particularly once you step back, might not be as high as you anticipate. It’s easy to overlook potential revenue dips or changes in the industry landscape.
- Personal Expenses in Retirement: Retirement can be more expensive than you think, thanks to rising healthcare costs, unexpected lifestyle changes and other factors.
Given these challenges, consulting with professionals can be incredibly beneficial. Business brokers, appraisers, CPAs and financial planners offer valuable insights into business valuation, growth projections and potential sale proceeds. The relatively small cost of hiring these experts is a smart investment compared to the potential losses from miscalculating.
5 Steps in a Successful Gap Analysis
- Determine Your Business Valuation: First, get a solid valuation of your business. This isn’t something you want to estimate yourself. Bring in a business broker, appraiser or acquisition specialist to get realistic figures. Knowing the actual value of your business is essential in determining where you are versus where you need to go.
- Assess Other Assets: Don’t just look at your business. Take stock of all your assets, such as savings accounts, investments, property and retirement funds. Add these up to get a clear picture of your current financial standing.
- Project Future Growth: Next, assess the future growth of your assets, including your business. This part can be tricky because market conditions and business cycles are always changing. Again, employing the service of a professional with expertise in these areas can reduce the margin for error.
- Account for Variability: Life is unpredictable, so factor in the possibility of bad years. Think about economic downturns, market shifts or even personal health issues that could affect your income. Planning for both the best and worst-case scenarios will help you stay prepared.
- Run the Numbers: Once you have a clear picture of your assets, projected growth and potential setbacks, crunch the numbers or hire someone to help you do so. Determine whether your business and other financial holdings will generate enough income to support your lifestyle post-exit. This exercise will help you identify any gaps between your financial needs and available resources.
Planning for retirement and succession isn’t as simple as just socking away a set sum of money and calling it a day. It’s a dynamic process that requires comprehensive and realistic planning. It’s important to understand that various assets won’t grow at the same pace, and market conditions won’t always be favorable. Be prepared for potential downturns and unexpected changes that may impact your savings or business cash flow.
A Word on Asset Growth and Fluctuations
Planning for the future can be tricky, whether it’s for your retirement or the long-term trajectory of your business. Getting a realistic assessment of how your assets and investments may grow will help you best prepare. You’ll need to consider not only your ongoing and future contributions, but also the years when the market takes a nosedive or unexpected expenses pop up. Some years, you might need to reinvest in your business or save less than you’d hoped because something unexpected came up.
It’s vital to prepare for several financial scenarios. Maybe your business doesn’t grow as anticipated, or perhaps there are times when contributing to investments and savings just isn’t feasible. Developing a strategy that considers uncertainties is critical to being prepared.
Keep in Mind Your Post-Business Goals and Expenses
As you edge closer to your departure, getting a clear picture of your goals becomes vital. What kind of lifestyle do you envision? Whether it’s jet-setting around the globe, diving into new hobbies or simply savoring some well-deserved relaxation, you’ll need to figure out how much these activities will cost.
It’s not uncommon to underestimate future expenses, with expectations that your cost of living will drop. However, more free time often means more chances to spend — be it on travel, entertainment, or leisure activities that weren’t part of your budget before.
If your target exit age is 65 or younger, it’s wise to prepare for a retirement that could last 30 years or more. This isn’t just a brief hiatus; it’s a whole new chapter of your life and you’ll need the financial resources to enjoy it to the fullest.
Create a Plan for You Based on Your Goals
Determining the “net present value” of your future expenses can help you get a lump sum target for the future value of your savings, investments and business. Factoring inflation is critical, as it reduces the purchasing power of your money over time. What seems like enough now might not cut it in 10 or 20 years.
Once you’ve identified this target, the next step is to figure out how to achieve it. This could involve growing your business, boosting your savings, or adjusting your retirement timeline if necessary. If your asset values or business revenue decline, you might need to consider postponing your exit or altering your lifestyle and spending habits to stay on track.
The Importance of a Gap Analysis: Prepare for the Future Starting Today
As mentioned, conducting a thorough gap analysis is critical in figuring out where you are now, and just as importantly, where you need to be. From there, you can plan the journey. What tweaks need to be made? Are there areas in your budget or lifestyle where you can cut back? How can you optimize the value of your business to ensure it keeps generating cash flow or fetches a good price when you decide to sell or step aside?
A key part of business succession/exit planning is making sure your business is set up to realize its maximum value. Whether you’re passing it on to family or selling it to your management team or a third party, you want to ensure you get the best return on your life’s work.
Ensure You Optimize Business Cash Flow and Valuation
This is something I will explore in future articles, but making your business as valuable as possible before you step away is optimal. This means streamlining operations, boosting profitability and ensuring strong cash flow.
Depending on your goals, you might consider bringing in experts like mergers and acquisitions specialists, investment banks or private equity firms to help with valuation and strategy. This becomes particularly important if you’re considering selling your business or handing it over to new leadership.
Succession planning also means identifying the right person (or people) to take over. Whether it’s a family member, a trusted business partner, or a third party, you want to ensure they’re well-equipped to continue the business’s growth and success.
Final Thoughts: Strategically Plan for a Prosperous Future
Succession planning requires careful planning, regular updates, and a clear idea of where you are now versus where you want to be. You’ll need a solid plan to grow your assets, optimize your business, and ensure you have enough saved to enjoy a comfortable retirement.
Whether it’s figuring out how much you’ll need post-exit, the future and present value of your assets, or developing your succession plan framework, it’s integral to start this process now.
I’ll discuss next steps and exit strategies in future articles, but for now, I hope this helps you understand the necessary steps for business planning, preparing for your exit and setting up your successors for success.
Jerry Maddaluna is the founder and lead financial advisor/financial planner at Luna Financial Group. Luna Financial Group engages in comprehensive financial planning partnerships with business owners to provide personal financial planning, outsourced personal CFO services, and assist with business planning needs, such as retirement plans, buy-sell planning, organizational structure, income tax planning and reduction strategies, optimizing valuations, employee retention strategies, and succession/exit planning.
