the business owner paradox
TRANSCRIPT
S T R E N G T H I NK N O W L E D G E
It's not too late, solve the business owner paradox
H o w t o A t t a i n t h e G r o w t h &G r a t i f i c a t i o n Y o u ' v e I m a g i n e d
A Glimpse of Our Holistic View
What do you expect the business will looklike in 20 years?
Business Growth vs. Owner GratificationThe Shirtsleeves to Shirtsleeves ChallengeRisk Optics vs Risk Aversion of OthersThe Premise for Success
Your Business End GameWhat do you expect the business will look
like in 20 years?
This is your view; what you want or expect.
How will you accomplish your end game and manage the issue of immediategratification versus busness growth?
Gratification vs. GrowthA real business owner paradox
Why is it that after many years, businesses with $1 million or lower annual revenuenever really grow?
Most parents would never consider raising a malnourished child. Yet many ownerswill take cash needed to grow a business to pay for their own wants. Toiling 60 and70 hours per week isn't enough to grow a business. It needs adequate cash("financial capital") or it starves.
These behaviors often explain why most companies can't be sold as they areessentially a "job" created for the founder. Few buyers want it.
Partial Deferred Gratification
After years of toil, the business generates more sales and profits. The ownercraves a reward for the sacrifice, so seeks compensation a little too much toosoon.
This partial abstinence may allow the company to reach $5 million or even $10million in sales. However, most companies hit this growth ceiling for bothfinancial and human capital reasons that leaves the owner unable to breakthrough to the next level.
A less common approach
2 Simplistic Scenarios Owner Views of Gratification versus Growth
Owner "A" decides to over-compensate both salary and distributions.
The business "needed" $200,000 to fund "typical" 4% per annum industry and market levelgrowth. Let's say the business was worth $5 million and paid the owner $250,000 per year. The owner took another $500,000 so growth is an anemic 2% per year.
Owner could have achieved 10% growth if $500,000 had been wisely reinvested in thecompany.
If the owner is operating a "lifestyle business" the "extra" amount received equates to 20years times $500,000 or $10,000,000 for gratification plus the $5,000,000 in companyvalue plus the 2% compounding for the 20 years (an extra $2,430,000) or $17,430,000.
The $7,430,000 company and some nice toys are all that show for the 20 years of effort
Owner “B” defers gratification, preferring growth.
This owner enjoyed a 10% year-over-year compounded growth. and had $33,700,000value to show for 20 years. The benefit of compounding provides almost double theeconomic benefit when compared to Owner A's gratification.
Owner B was 30 when the business was worth $5,000,000 and 50 when it was worth$33,700,000. By age 65 the business was worth $142,000,000 in value..Assume the business stayed in the family instead of being sold . Assume the samebusiness growth (from expanded offerings and markets) was sustained. Assume eachof three adult children have a one-third interest and benefit from magnificent taxplanning.
Their one third interest is valued at $47,333,3333 ($142,000,000/3) by 40. If they operatethe business for a generation or 20 years each one third equity interest owned could beworth ~$200,000,000 when they reached 60. Even with the "dilution" of ownership theworth was "greater" than when it was received by almost four-fold, 20-years later.
Second ScenarioThe Power of Compounding
The "Shirtsleeves to Shirtsleeves"challenge
What is the reason the founder's advisors may suggest selling the concentrated riskasset ? Is it driven by risk aversion? If so, whose?
Does the family need the liquidity? Would a financial institution manage the proceeds from a sale? Would they be more risk adverse? Would they select a passive portfolio?
Would it achieve the levels of yield and growth (total return) that would allow thefamily to maintain their existing lifestyle(s) or would principal erode as the founderand spouse spent it?
Risk Aversion versus Risk Itself
The question is whether risk aversion and by whom and not necessarily riskalone may, in part, contribute to the decline in wealth from generation togeneration.
It is possible to design a balance between family interests and wealthmanagement interests to identify, measure, report, manage and mitigate therisks of this asset on a regular basis for all parties involved.
Who has skin in the game? How do all of these parties get compensated?
This is why liquidity, legacy, leverage and learning must be part of transitionevent planning.
This requires an independent perspective with the wherewithal to ensureadvisors and families are aligned when such important decisions are madewithout inadvertently placing biases or short-sightedness into the mix.
Consider the additional "mess" of a disruptive event like death, disability,divorce or dispute.
Whose Risk Optics?
Your First 2 Options
If business value comes in below what you think its worthor the amount of capital, net of expenses, seems unlikely to generate the amountcash flow your lifestyle requires, you have 2 options.
If you want to know what these are, its going to require real numbers and an actualindepth valuation of the business, including the risk drivers.
Then we can discuss your options and time frames.
The very premise of a 9- or 10-figure company suggestsfamilies CAN succeed in
beating the odds with organicgrowth and M&A.
Vision. Direction. Execution.
Carl Lloyd Sheeler, PhD, ASA, CBA, CVA 2049 Century Park East, Suite 2525Los Angeles, CA 90067Phone: 1-310-499-4842 CA 1-646-328-1981 NYEmail: [email protected]
Robin Coady Smith1330 Avenue of the Americas, 23rd FlNew York, NY 10019Phone: 1-646-328-1982Email: [email protected]
What would it mean to you to resolve your paradox?