When was the last time you calculated the percentage of your net worth tied to the value of your business?
When you started your business, its value was probably negligible. Unless you bought or inherited your business, it was not worth much when it opened, but over time, the proportion of your assets tied to your business may have increased.
Imagine a hypothetical business owner named Tim, who starts his business at age 30. He has a little equity in his first home and a small retirement fund. When Tim starts his business, it has no value, so it is not yet taken into account in calculating Tim's net worth. However, time passes and by the age of 50, Tim has accumulated $ 600,000 in equity in his home, his retirement savings have grown to $ 400,000, and his business has flourished and is now worth $ 4,000,000. Tim's business has grown to account for 80% of his net worth.
However, time passes and by the age of 50, Tim has accumulated $ 600,000 in equity in his home, his retirement savings have grown to $ 400,000, and his business has flourished and is now worth $ 4,000,000. Tim's business has grown to account for 80% of his net worth.
Tim knows the first rule of thumb for investing is to diversify, which he's careful to do with his retirement account. Still, it has not achieved general diversification due to the success of its business. What's more, Tim may have unknowingly passed the so-called Freedom Point, which is when the net proceeds (that is, after taxes and expenses) from the sale of his business would provide him with enough money. to live comfortably for the rest of your life. Your lifestyle determines your Freedom Point, but when you exceed it, it is worth considering the risk you are taking.
If this pandemic has taught us anything, it is that nothing is certain, and a thriving business can one day turn into a struggling company overnight. When your business makes up the majority of your net worth and selling it would generate enough money to retire, there is no financial reason to continue owning your business. You may enjoy the challenge, social interactions, and creative process of building a business, but maintaining it can be unnecessarily risky. When you've reached the top of Freedom Point and want diversification, but still don't want to retire, you have these 3 options:
Sell a minority stake: In a minority recapitalization, you sell less than half of your shares. Often sold to a financial investor, such as a private equity group, a minority recapitalization allows you to diversify your net worth while continuing to control your business.
Selling a majority stake: In a majority recapitalization, you sell more than half of your shares to an investor who will likely ask you to continue running your business for many years. You can diversify your assets, keep some capital in your business for when the investor sells.
Sell your entire company (100% of the shares): When you sell your company, as a requirement of the buyer, you will likely have to accept a transition period where you will continue to manage your company as a division of your acquirer's business for a specific period of time. This time can be from one year to seven, but the average is three years. So, if you've gotten past Freedom Point and see yourself wanting to quit in the next three to five years, it may be worth considering selling your business now.
Building a successful business is rewarding, but when it weighs too heavily on your personal net worth, it is important to consider the risk you are taking and the options you have to reduce it.
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