The what’s my number question was a question originally posed to me some years ago by Adam Young, one of the top team at Jarrovian Wealth, and it’s one that I have used repeatedly with clients since.
The what’s my number question is really about how far do you want to take your business in order for it to deliver the lifestyle you want, now, and in retirement?
However, there is probably a question that needs to preceed the “what’s my number” question and that is:
- Are you passionate about your business? Or,
- Are you passionate about lifestyle that the business deliver’s?
Because, if you’re passionate about your business you’re likely to stay in it for longer and maybe never retire, in which case the what’s my number question might be completely immaterial.
Additionally, given that you are building a business you are likely to be financially “savvy” so the answer to the question is often a function of a number of different income streams which may have built up during your entrepreneurial life and might include:
- Sale of the company
- Income from any ongoing involvement in the company
- Whether or not you have purchased the company premises (& will continue to rent them)
- Income from any other properties (buy to lets / holiday homes etc)
- The size of your pension
- More recently, things like cryptocurrency investment
- The expected state pension (at the time of writing, circa £15k pa for a married couple)
Obviously, you may want to be retired for a long time (fortunately, I love work, so I don’t expect to be… but I will scale back, which is why I’m building my team) and there is “the rule of 4%”. The 4% Rule is a practical “rule of thumb” that suggests you can withdraw 4% from your retirement funds each year without adversely depleting the pot. The objective is to retain a steady income stream while maintaining an adequate overall balance for future years. The idea being that withdrawals will primarily consist of interest and dividends. The “rule” suggests that in adopting this approach the pension pot is likely to last your lifetime. Having said that there are some challengers to the 4% rule. The majority of which query whether or not 4% is too much given the investment climate over the last few years.
But as a business owner and entrepreneur you are likely to have an asset that others don’t; your business. Which has, a sometimes significant, value.
The value of a business
So, what is a business worth… how do you calculate that?
Some time ago I did a master’s degree in business administration, part of which involved an exercise where we had to value a series of different businesses using a variety of methods, all of which had very posh names; the discounted cash flow method, the internal rate of return method, the price earnings (P/E) method to name but a few.
The conclusion to the exercise was the value of any business is worth what somebody wants to pay for it! Which is distinctly unhelpful! The bottom line is, all of these fancy metrics sometimes don’t really account for much.
However, despite the vagaries of the methods of valuation there are things that you can do to increase the value of a business.
But what can you do to increase value?
There are a number of approaches and ideas that can be employed to make the business more valuable, and these include:
- Diversifying your customer base
- Buying other businesses
- Making yourself redundant
- Building repeatable income
- Developing products that allow you to “do the work once but get paid repeatedly”
We have all heard horror stories of companies that have had a blinding success but with just one customer taking the lion share of company’s turnover, or perhaps having a very friendly relationship with just one person in their biggest client. The customer then chooses a different supplier or that one person leaves. The company then collapses because it was built on a bed of sand. In an ideal world, to extract maximum value from a company sale, no one client should take more than 10% of a company’s income. You need to ensure you have a diversified customer base. Checkout blogs on sales and marketing for additional information.
We have a number of clients, and know a number of others, that have gone on company buying sprees, some with their own money, some with venture capital. One fire and security company, big in the South with fire services and weaker in the North with security services sold out to a major (household name) trade company who promptly bought another company, big in the North with security clients and weak in the South with fire clients. The two parts of the business complemented each other beautifully and the new owners merged the companies creating a bigger more balanced company. After the various merger wrinkles had been ironed out, the combined company was sold for many many many times the value of the two original companies. The guy we knew, the MD of the original southern company, was impressed and enraged in equal measure. So much so that with cash from his personal bank account he promptly set up again to take advantage of this “better” and more lucrative approach. This illustrates the point that is usually better to buy companies outside of your geographic area with complementary products rather than direct competitors. You can build value further by cross selling in geographic areas and across product lines.
Businesses are worth significantly more to someone else if you can honestly say (and prove) “I don’t do much work, I spend most of the time on the golf course” rather than “I work damn hard in this business typically doing 80 hours a week”. The first comment would indicate the business runs itself and whatever you take from the business can be added back in as profit for the new owner. The second statement means the business is entirely dependent on you which means the value is wrapped up in you. So, if you leave there’s likely to be a problem. In most businesses the bottleneck becomes the owner. The bottom line is, if you want to increase the value of the business build it so that it works without you. Essentially, you need to build the team around you. Checkout the many blogs on team building below.
The most valuable businesses are those that produce an ongoing repeatable and predictable income stream. I was at a conference last week and a guy called Kevin Whelan, who goes by the name of “The Wealth Coach”, suggested that a business with repeating and predictable income was typically worth more than 8 times a “normal” business. Many contracting businesses can develop ongoing income streams by servicing a portfolio of equipment, for instance mechanical and electrical contractors, lift companies, IT companies, FM companies. All of which will undertake one-off installation projects all of which need ongoing servicing and repairs. The bigger the “servicing” component of the business the more valuable the business.
The archetypal example of the “work once, get paid repeatedly” approach are software companies. We have worked with a number of companies some small, some large, one a one-man band. Each of these companies had spent time creating a software product that was then sold to multiple organisations. Usually, they derived payment as a one off upfront fee and then essentially an ongoing subscription fee that provided access to future upgrades. Very predictable and very lucrative. Another example, in a similar vein, would be training companies developing training materials once, that are sold, multiple times… At the extreme, but possibly not a business in the normal sense, is JK Rowling. She has done an awesome job of delivering a spectacular return on investment and working once getting paid repeatedly… 500m times! What if you could do that with training materials, or software, or something else…
Bringing it all together – what it means
The business sale, or ongoing revenue derived from it, is likely to be your biggest asset that drives your number. However, along the way you may have also collected a veritable stable of other assets. At some point the likely value, or revenue derived from these assets, should be calculated in order to understand the current and likely future position.
We recently did some work, alongside the team at Jarrovian, with a small company, two directors both of whom were relatively young. They had a figure in mind for what they would like to retire on, in this case it was an annual income value, but they had absolutely no idea on how close they were and it had never occurred to them a calculation could be made.
We did some “quick and dirty fag packet” sums:
- Current pension assets and likely growth rate
- The impact of future pension contributions
- Current ISA assets and anticipated growth rate
- The income from two buy to let houses
Given their age, these guys were some way off retirement but simply undertaking the fag packet calculation allowed them to appreciate that if they retired tomorrow their current assets already delivered an income beyond the number they had in mind! They were astonished!
At this point two scenarios, at different ends of the spectrum, usually emerge:
- Relax, give it all up now and wander off into the sunset… “thank you very much, job done”
- Think wow! Take a deep breath and say if we’ve already got our bases covered what else can we do?
The second option can, potentially, turbo charge your ambition allowing you to take more risks knowing that your backside has already been covered. Marco, my coach, call’s this “the cat food option”… you know you’ll not be eating cat food in retirement, knowing this allows you to relax and get more creative.
However, we would, as we did in this case, indicate a note of caution and that is; house prices have been known to drop 30% as has the stock market! So, in this instance, whilst they have taken the turbocharged option, they have also realised they need to build in a “margin of safety”. This margin of safety will be the focus for the next few years.
The point is in undertaking an exercise like this will allow you to either breathe a massive sigh of relief, alternatively, it may stoke further the fires of your ambition. There is no right or wrong answer.
What’s next? – A word of warning
If selling the company is the answer, or indeed, prior to withdrawing from it and letting somebody run it with you taking an income, think long and hard prior to signing on the dotted line. We think you need to be very clear about what you are going to do next. There are a lot of very bored rich entrepreneurs with nothing to do. Depending on your age, you also need to account for the impact on your kids. In a number of instances the kids of “sold out” entrepreneurs go off the rails. They see their parents kicking back going to the golf course and doing nothing much and think they’re entitled to do the same!
Apologies to the golfers amongst you (sorry Kay), but an American writer Saul Bellow wrote “Retirement is an illusion. Not a reward but a mantrap. The bankrupt underside of success. A shortcut to death. Golf courses are too much like cemeteries.”
The message here is; be careful what you wish for… It can provide a toxic role model.
How does this fit with my management system?
All of the core management system standards (Quality – ISO 9001, Environmental – ISO 14001, Information security – ISO 27001 and Health and Safety – ISO 45001) require companies to define their goals and ambitions. So, if selling, or deriving an ongoing revenue whilst taking a back seat, is part of the process necessary for you to ensure you achieve your number, then that is a legitimate objective. We fully understand that this might not be something openly declared but there are a multitude of actions that need to be taken to get you there. Each of the key approaches detailed above; diversifying the customer base, buying other businesses, making yourself redundant, building repeatable income and the do the work once get paid repeatedly approach will each involve specific decisions and people doing stuff. Lots of which are essentially “objectives and targets” and each of which will involve developing staff, another key component of all of the above standards.
I think (clearly you are allowed a different opinion) that it is a great idea to take stock of where you are now and think about the assets that you have accumulated and how they will serve you in the future.
I also think the qualities that make entrepreneurs successful are the same that make retirement extremely difficult. You get identity and purpose, you are part of a tribe, you have a structure and a sense of achievement… That’s an awful lot to give up.
As somebody once said “When you retire you go from who’s who to who’s that? Not a great epitaph. But there are no shortage of challenges facing society, so there are plenty of places should you wish to retire (once you have established your number) that you may wish to apply your experience and skills.
Alternatively, like one of our longest served clients and good friend of mine Reg Coote of Unique Lifts you might just wanna do it all again. As a report commissioned by Coutts Bank Beyond the first business: the myths, risks and rewards of being a serial entrepreneur what matters most is not making a shed load more money (they didn’t say “shed load” that’s my vernacular), but making a meaningful contribution to the growth of an organisation and the personal lives of the people within it… you may simply be driven by the thrill, excitement, pride and satisfaction derived from growing your team so that they help your clients and in doing so you build something worthwhile.
Disclaimer: Clearly, Statius are management consultants not financial advisors we will have an opinion on some of the approaches our clients adopt but detailed financial advice needs to come from an appropriately qualified financial advisor.
Related tools and ideas
- Marketing & sales (relates to diversifying the customer base)
- Training and development (relates to making yourself redundant)
- Jarrovian Wealth – specialists in entrepreneurs
- The Wealth Coach – specialists in developing recurring income streams
- Beyond the first business: the myths, risks and rewards of being a serial entrepreneur
- See the blogs related tools and ideas