There are three primary "gaps" that are crucial in business planning: the owner's wealth gap, the business's income gap, and the business's value gap.
The wealth gap is a simple concept: how much do you need to sell your business for in order to fund your personal financial goals?
Imagine Lisa owns an equipment leasing company in Pennsylvania that she inherited almost thirty years ago. She is approaching her 60th birthday and is contemplating selling the business so she and her husband can travel to watch her son compete on the Korn Ferry golf tour.
In addition to following their son, they want to continue traveling the world and taking their children and grandchildren on vacations. Lisa's husband also buys vintage cars and fixes them up for sale—a hobby that sometimes breaks even but often requires a cash infusion to stay afloat.
In conjunction with their wealth manager, they estimate they require $250k/year in post-tax, inflation-adjusted dollars to maintain their current standard of living. They also want to leave a legacy for each of their two children when they pass.
Assuming they don't sell their home (after all, they need a place to rest between trips), Lisa and her husband have about $2.5 million in stocks and bonds in retirement and brokerage accounts. Factoring in inflation, a reasonable growth rate, taxes, social security, healthcare, etc., their wealth manager estimates they will need $5.5 million to provide that stream of future income without taking an unreasonable amount of investment risk.
Their wealth gap is $3m--the amount of money they need to sell their business for (net of taxes, fees, etc.) to provide for their future financial goals.
A business's income gap is a measure of how much net income your business could generate if it was firing on all cylinders.
If Lisa's company operates at an 8% net margin on $10,000,000, she takes home $800k/year in EBITDA. When we compare her company to businesses in the same industry and sector with similar top line numbers, we find that the best-in-class companies are operating with a 12% bottom-line margin. Said more simply, Lisa is potentially leaving $400k/yr. in net income on the table.
There can surely be reasons specific to her business that Lisa maintains an 8% net margin instead of a 12% best-in-class bottom line, but the income gap is a measure of how efficiently a business is generating income. While it may not be possible for her company to operate at the high end, this calculation can give Lisa a starting point to improving her processes.
The value gap is a similar concept taken one step further. While we
were comparing Lisa's income to best-in-class performers, we also compared her potential private market multiple to the the top dogs in her industry. Lisa completed our onboarding process and we calculated a current range of multiples between 2.5x and 4.25x EBITDA.
With income of $800k/yr., her current range of value for the leasing company was $2m--$3.4m.
The best performing companies in her sector with similar revenues were trading at a multiple between 5x and 6.5x EBITDA.
The best companies had bottom line revenues of $1.2m with a high end multiple of 6.5x. A whopping $7.8m potential sale price for the same amount of revenue that Lisa was generating.
The value gap of Lisa's company could potentially be as large as $5.8m! Even with relatively small adjustments, she can take steps to close that gap...time to get to work.
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