Aligning business goals with financial plans

✨ In summary

Business owners need financial advisors to give them clarity on how reliant their personal financial plan is on liquidity from exiting their business.

This exercise of providing client's clarity their liquidity goals and the goal valuation should be quickly followed with a benchmarking exercise that establishes the business performance metrics needed to achieve that goal valuation by the client's ideal exit timeline.

Equipping owners with these metrics helps them tangibly see how business performance contributes to their long-term life goals.

Making business owner financial plans actionable

Most business owners know how important their business is, but can't articulate exactly the role it will play in funding their life goals. Owners are also typically focused on growing their businesses and value practical benchmarks they can use to track progress towards larger goals.

Advisors can use liquidity goal setting and goal valuation estimates paired to show owners how the business could fund their life goals.

Two simple performance benchmarks make tracking progress tangible for business owners:

EBITDA needed to reach goal valuation: The earnings the business needs to generate to reach this goal valuation
Goal revenue growth: The revenue growth needed each year to meet that EBITDA goal

By focusing on simple top and bottom line metrics, advisors can avoid playing the role of a valuation optimizer or business consultant while still helping owners feel like their financial plans is actionable.

Goal EBITDA

Although business valuation is influence by many factors, with variations method to method, the relationship between earnings before interest, taxes, depreciation, and amortization (EBITDA) and valuation is strong.

Advisors can use the relationship between current valuation estimates and normalized EBITDA to generate rough estimates of the amount of earnings needed to reach the goal valuation.

Estimating Goal EBITDA

Goal EBITDA =  Goal Value  / Current Valuation Estimate / Normalized EBITDA

Since business's may earn larger valuation multiples as their earnings go up, it's recommended advisors reference industry EBITDA multiples while estimating Goal EBITDA to see what earnings level the next best multiple requires.

Goal revenue growth

Once Goal EBITDA is estimated, establishing an estimate of the revenue growth needed to reach that earnings level is a great next step.

To do this, compare the most recent year of EBITDA to the Goal EBITDA and apply an annual growth rate calculation.

Estimating Goal Revenue Growth

Where:

Goal EBITDA = the earnings needed to reach goal value
EBITDA (t-1) = the most recent year of earnings
N = the years between today and ideal exit

This approach assumes EBITDA margin remains constant going forward. Although it is prudent for business owners to monitor margins and compare them to benchmarks, assuming a fixed margin allows advisors to discuss this metric in more simple terms with clients.

Frequently asked questions

Why should an owner's personal financial plan be tied to business goals?

The liquidity generated from an owner's exit from their business is often meaningful contributor to an owner’s retirement or wealth plan.

By knowing the amount of liquidity their personal plan requires, advisors can estimate the business value needed to support those goals, and establish business benchmarks that meet this goal valuation.

Advisors that build trust in this way will be well positioned to help owner's manage that future liquidity when the time comes.

What if the EBITDA or revenue growth needed to reach their goal value is unreasonable?

Goal valuation should be based on an assessment of how much liquidity is required at exit to fund a client's life goals.

If the growth required to reach goal valuation seems unreasonable within the client's ideal exit timeline, there may be an over reliance on business liquidity to fund the client's personal plan. That's to say, their goal valuation may be unreasonable.

Deeper conversations around diversifying current earnings from the business to increase savings rates may be appropriate to adjust the reliance on liquidity.

How do I help the owner track progress toward these goals?

Revisit these goals in line with annual check-ins and use the opportunity to re-estimate their business valuation and goal valuations. Showing owners whether they are on track or off track for their plan is a practical way to engage them in the planning process.