Goal Valuation & Liquidity

Estimating goal valuation

Goal valuation is mainly driven by the liquidity goals the owner has at exit. When an owner exits their business, the Equity Value will be translated into net proceeds by accounting for their share of equity owned and taxes and fees at the time of exit. 

Estimating Goal Valuation

Goal Valuation = Net Proceeds Needed at Exit / (1 - Tax & Fees on Exit Cash) / Ownership Percentage

Net proceeds needed at exit

Net proceeds needed at exit represents the liquidity the owner needs to fund their life after exit. 

This may include:

• Retirement lifestyle
• Healthcare
• Legacy goals
• Debt pay down

Estimating net proceeds needed is closely tied to long-term personal financial planning practices. It requires identifying future income needs and then determining the required value of that income at the time funds will begin to be drawn down.

This can be done using a Present Value or Net Present Value

These calculations will reference:

• Time period: The years between exit and the end of the client's plan
• Payment or Cash Flow: The annual income that needs to be funded by net proceeds
• Interest rate: An estimate of the interest that net proceeds may generate each year after exit
• Inflation rate: An estimate of the annual inflation for the timeline
• Discount rate: The difference between the Interest Rate and Inflation Rate used to discount future cash flows

RISR provides a simple calculator to advisors and their clients that collects the inputs above and estimates net proceeds needed from exit. This tool can be used as a conversation start and lead in to deeper personal financial planning and modeling for the client.

RISR estimates Net Proceeds at Exit with the following assumptions:

• Annual income required remains the same each year after exit
• The proceeds are received in a lump sum in the year of exit
• Annual income from net proceeds begins immediately after exit
• Legacy funds are needed at the time of exit (and so are added the the present value of annual income needs to determine total net proceeds needed at exit)
  
  

How RISR estimates Net Proceeds Needed at Exit

Net Proceeds Needed at Exit = PV of Annual Income Required + Legacy Goals

In the event that net proceeds required has already been estimated using deeper cash flow modeling, advisors can input that directly into the tool and RISR will use it to estimate goal valuation. See the following section on engaging clients to determine liquidity needs for guidance on how to navigate a deeper exercise for estimating net proceeds required from exit with owners with owners.

Taxes & fees at exit

The estimated taxes & fees that will be applied to proceeds at the time of exit. Taxes & fees can vary widely based on the exit structure, state, and more. Scenario planning with business owners to simulate taxes & fees at exit is an excellent place for advisors to build trust and provide tangible value to business owners. 

Discovering client liquidity needs

Estimating net proceeds needed is closely tied to long-term personal financial planning practices. Adding a few simple steps to your current personal planning process will show owners you care about their most important asset and give them clarity on how it fits into their life goals. 

1) Identify how much of the client's retirement income or legacy goals will not be covered by assets outside the business (savings, investments, etc.)

• When does the client want to exit their business / retire?
• How much income will they need each year after exit / in retirement?
• Are there any legacy goals you would like to fund? 
• How much of the income and legacy goals will be funded by assets outside of the business (savings, investments, etc)?
• How much income or legacy goals is remaining that needs funding? 

The remaining income that needs to be filled is sometimes referred to as the wealth gap. In cases where the client has all of their needs covered, this exercise becomes more about ideal or desired state. The same principles for estimating net proceeds required and goal valuation apply in both cases. 

2) Estimate the net proceeds from exit needed to generate that income / legacy funding

Advisors can work backwards from the gathered information above to identify net proceeds needed from exit using a Present Value or Net Present Value calculation.

These calculations will reference:

• Time period: The years between exit and the end of the client's plan
• Payment or Cash Flow: The annual income that needs to be funded by net proceeds
• Interest rate: An estimate of the interest that net proceeds may generate each year after exit
• Inflation rate: An estimate of the annual inflation for the timeline
• Discount rate: The difference between the Interest Rate and Inflation Rate used to discount future cash flows

3) Use net proceeds required from exit to back into goal valuation needed

Goal valuation is the valuation the business needs to achieve to meet the owner’s liquidity goals, defined above as net proceeds need from exit.

To back into goal valuation, advisors will need to estimate the potential taxes and fees on the exit cash and identify the percent of equity the client owns. 

Goal Valuation = Net Proceeds Needed at Exit / (1 - Tax & Fees on Exit Cash) / Ownership Percentage

Today, the RISR tool simulates net proceeds as a lump sum received in the year of exit, with taxes & fees being applying within that year. Until RISR develops this tool, advisors wanting to provide more detailed tax scenario planning will have to rely on custom calculations or cash flow modeling tools to simulate proceeds being spread over time. 

4) Compare goal valuation to current valuation

The final step to helping business owners understanding their liquidity goals and goal value is to compare the estimated goal valuation to their current valuation estimate.

This is primarily to determine if their financial plan is based on a reasonable goal. 

Conversations around feasibility of reaching the goal valuation need to be had. This can be done by looking at how much their valuation needs to grow and comparing it to the time between today and their planned exit timeline. 

Calculate benchmarks to gauge how feasible it may be to reach the goal value:

• EBITDA needed to reach goal valuation: What earnings does the business need to generate to reach this goal valuation?
• Goal revenue growth: How much revenue growth is needed each year to meet that earnings goal by exit? 

If the growth required to reach goal valuation seems unreasonable, there may be an over reliance on business liquidity to fund the client's personal plan. Deeper conversations around diversifying current earnings from the business to increase savings rates may be appropriate to adjust the reliance on liquidity. 

If the growth seems reasonable, advisors can use these EBITDA and revenue growth benchmarks to align the clients business key performance indicators (KPIs) with their personal financial plan.