Hoping to retire after selling your business ? One of the most common — and costly — mistakes business owners make is discovering too late that the value of their company is not enough to fully fund their retirement. In exit planning, this difference is known as the business owner’s “value gap.”
This article will help you understand how to calculate your “value gap” and, more importantly, close the gap if one exists to ensure your comfortable next chapter.
Calculating Your Value Gap –
A business owner’s value gap is the difference between:
- What the owner needs from the business to achieve their personal, financial, and post-exit goals; and
- What the business is actually worth today in the open market.
Formula:
Value Gap = The Owner’s Required Exit Proceeds – The Business’ Current Value.
Most business owners assume these numbers are close, but, in practice, they rarely are. They are relying on “hopeiem.” Below is a seven (7) -step process for determining your “value gap.”
Step 1: Determine Your Required Exit Proceeds:
Exit planning actually starts with the owner — not the business. The first step is to calculate what you need to comfortably retire; Important considerations include:
- Personal Financial Needs –
A business owner’s retirement should satisfy their:
- Desired annual post-exit income;
- Lifestyle costs;
- Inflation assumptions; and
- Longevity planning.
- Sufficient Capital Requirements –
The business owner’s nest egg should include provisions for:
- One-time goals, such as real estate, travel, gifting, and philanthropy;
- Emergency reserves; and
- Legacy or estate objectives.
- Minimal Taxes and Transaction Costs –
The business owner’s nest egg should also cover:
- Possible income and/or capital gains taxes;
- State and local taxes; and
- Deal fees and professional costs.
- Risk Tolerance –
Last, the business owner has to be able to sleep at night. Accordingly, their exit might include:
- A willingness to accept earn-outs, seller notes, or retained equity; and
- A preference for certainty vs. upside.
The result is an inclusive, after-tax number the owner must walk away with to ensure their carefree retirement.
Step 2: Establish the Business’ Current Market Value:
Next, determine what the business is realistically worth today, not what it could be worth “on a good day.” This requires:
- A defensible valuation method based on income, market value, or asset value;
- Normalized EBITDA or cash flow;
- Market multiples appropriate to the business’ size, industry, and risk; and
- Adjustments for owner dependency and concentration risk.
Importantly, this valuation is market-based, not a theoretical or aspirational one. [Note: Internal transfers must be valued based on “Fair Market Value” (FMV).]
Step 3: Calculate Your Value Gap:
Once both numbers are known, your value gap becomes clear, as illustrated below:
The business owner’s required after-tax proceeds equals $10.5 million, but the business owner’s current estimated, after-tax business value is only $6.5 million; hence, the value gap is $4.0 million.
The important point here is that the business owner’s value gap is not a failure, but rather a business exit planning insight – and opportunity.
Why Most Value Gaps Exist –
Value gaps can exist for many reasons, like:
- An overreliance on the owner;
- A weak or inconsistent cash flow;
- A customer or revenue concentration;
- A lack of management depth;
- Poor financial reporting;
- An unaddressed operational or legal risk; and
- Unrealistic expectations about valuation multiples.
A certified business exit advisor can help you fix many of these problems to accelerate the value of your business and close your value gap.
Step 4: Identify Value Creation Levers:
Bridging the value gap requires intentional value creation. Common levers include:
- Increasing Sustainable Cash Flow –
- Improve pricing and margins;
- Eliminate non-essential expenses; and
- Strengthen recurring revenue.
- Reducing Risk –
- Diversify customers and suppliers;
- Institutionalize processes; and
- Formalize contracts and compliance.
- De-Risking Owner Dependency –
- Build a leadership team;
- Delegate decision-making authority; and
- Create documented operating systems.
- Improving Financial Transparency –
- Clean up accounting;
- Separate personal and business expenses; and
- Prepare for quality-of-earnings scrutiny.
Step 5: Using Time as a Strategic Asset –
Most value gaps cannot be closed overnight. The most effective exit plans often span 3 to 5 years, allowing time to:
- Implement operational improvements;
- Demonstrate consistent results;
- Establish buyer confidence; and
- Let value compound.
Time reduces risk, and risk reduction drives valuation.
Step 6: Considering A Partial Liquidity or Alternative Exits –
Sometimes the gap is best bridged structurally, not operationally.
Options may include:
- Partial sales or recapitalizations;
- ESOP transactions;
- Management or family buyouts; and
- Retained equity with future upside.
These strategies can reduce risk while still meeting financial goals.
Step 7: Aligning Your Exit Strategy with Reality –
Closing the value gap may require:
- Adjusting your growth strategy;
- Extending the exit timeline;
- Reframing lifestyle expectations; and
- Revisiting risk tolerance.
The most successful owners remain flexible, but informed.
The Role of a Formal Exit Plan –
An exit plan transforms the value gap from a surprise into a strategy by aligning:
- The owner’s personal goals;
- Business strategy;
- Financial reality; and
- Market timing.
Owners who identify the gap early have options. Those who discover it late have constraints.
Final Thoughts –
A business owner’s value gap should be viewed as a roadmap. When understood early and addressed deliberately, it becomes the catalyst for building a business that not only sells but supports the life the owner intends to live after the sale.
Did you like the content in this article ? For more information about business exit and succession planning, the author has posted his entire series of business exit and succession planning articles on the media page of his website at www.greaterprairiebusinessconsulting.com.
About the Author:
James J. Talerico, Jr. is an award-winning author, blogger, speaker, and nationally recognized small to mid-sized (SMB) business expert.
With more than thirty- (30) years of diversified business experience, Jim has a solid track record and an A+ BBB rating helping thousands of business owners across the US and in Canada tackle tough business problems to improve the performance of their organizations.
His client success stories have been highlighted in the Wall St. Journal, Dallas Business Journal, Chicago Daily Herald, and on MSNBC’s Your Business. He was named “Texas Business Consulting CEO of the Year,” by CEO Today Magazine, identified as a “Top 10 Management Consulting Entrepreneur to Watch” by Entrepreneur Magazine, was listed among the “10 Most Visionary Companies to Watch” by The Inc. Magazine, recognized as a “Top Visionary Entrepreneur to Watch” by MSN.Com and has also been ranked among the “Top Small Business Consultants” followed on Twitter.
For more than half a decade, Jim was a regular guest on “The Price of Business,” a nationally syndicated radio program on Bloomberg Talk Radio and has also appeared as a subject matter expert on many FOX Radio interviews. He is a regular contributor to several blog sites and has frequently been quoted in publications like the New York Times, Dallas Morning News, Philadelphia Inquirer, The Entrepreneur’s Review, The International Exit Planning Association’s blog site, and on INC.com, in addition to numerous, other industry publications, radio broadcasts, business books, and Internet media.
Jim received a Gold “Stevie Award” for “Thought Leader of the Year,” a Gold “Stevie Award” for “Media Hero of the Year During Covid” and a Bronze “Stevie Award” for “Best Entrepreneur” in the Category of “Business and Professional Services” at the American Business Awards® in New York City. The competition received more than 3,700 nominations and is the premier accolade for business excellence in the US honoring organizations of all sizes and industries. Jim also received an “Outstanding Leadership Award” at the Money 2.0 Conference for his contributions to the financial services industry.
Jim is the author of “8 Steps to Becoming an ETHICS FOCUSED ORGANIZATION,™” a small business certification program that utilizes a unique eight – (8) step approach for strengthening ethics in any organization. The certification program won the Better Business Bureau’s “Torch Award for Ethics” for the North – Central Texas Region, the International Better Business Bureau’s “ Torch Award for Ethics,” and a Gold “Stevie Award” for “Ethics in Sales” at the International Sales & Customer Service Stevie Awards®. Participants who complete this certification program are eligible to receive eight – (8) continuing education units from the University of Texas’ Division of Enterprise Development.
Jim received his Certified Business Exit Consultant (CBEC)® designation from The International Exit Planning Association (IEPA) to help entrepreneurs, small business owners, family businesses, and middle market companies maximize their business exit, and he received his certification in succession planning from the ASPE. Jim currently Co-Chairs The International Exit Planning Association’s Education Committee.
Jim is also a Certified Management Consultant (CMC)® and has been an active member of the Institute of Management Consultants. The Certified Management Consultant® mark is awarded by the Institute of Management Consultants USA (IMC USA) and represents evidence of the highest standards of consulting, a commitment to continuous development, and an adherence to the ethical canons of the profession. Less than 1% of all consultants in the world are Certified Management Consultants (CMC.)®
