How to Calculate Your Wealth Gap

Last week, we talked about the wealth gap and how it affects business owners when the time comes to sell or leave their company. It should be a crucial component of your exit plan. However, it needs to be calculated long before your actual exit.

To recap briefly, the wealth gap is the difference between the resale value of your business and what you need to live your ideal post-business lifestyle. Even your exit plan doesn’t involve selling your business (or cashing out on your share of the ownership stake), then the wealth gap still applies. You have to understand your overall return on investment (ROI) and calculate your wealth gap to make sure you are setting yourself up for a successful retirement.

We featured a basic calculation of the wealth gap in last week’s article, but today we want to get into some more details and factors to consider.

Timing is Everything

The first thing you have to determine is the timing. When would you like to retire? When do you plan to sell or leave your business? Figuring out the projected timeframe will enable you to reverse engineer your wealth gap calculation. It helps on multiple fronts:

1. You can project the value of your company when you expect to sell it, based on growth patterns, inflation, economic cycles and other industry trends.
2. You can project your living expenses for that retirement year and beyond, so you know what you will need to save between now and then (as well as what you will need to get out of selling your stake in the business).
3. You can establish a timeline, so you know what you need to earn, invest and put away between now and the time you plan to leave the business in order to eliminate any wealth gap.

Dividend Rates

Another factor to consider is the dividend rate as it relates to any of your investments, especially your business. It is the total expected dividend payments that come from an investment. This will help you in projecting the ultimate value of your business as you analyze the market trends, stock values, etc. You can also analyze your stocks, retirement savings and other investments outside of your business (if you have any) to understand how those may help close the wealth gap.

Studying Economic Cycles

You really want to pay close attention to natural economic cycles. There are always ebbs, flows and self-corrections in the stock market and just about every industry. Study these cycles and analyze the business trends that relate to your company and your overall investment portfolio. Inflation can also be factored into these calculations and projections. Again, the goal is to determine your final ROI from your business and other investments. Will that number meet or exceed what you project as your necessary post-entrepreneurial living expenses?

Cycle Analysis

There are different ways to look at economic cycles as they relate to your investment(s):

• Secular Cycle—Analyzing a 10-30 year period.
• Business Cycle—Analyzing a 1-10 year period.
• Tactical Cycle—Analyzing a 1-12 month period.

As you build your exit plan and calculate your wealth gap, you can study these cycles. If you plan to sell the business and retire in 15 years, then you will be analyzing all three cycles above. If you are hoping to retire within a year, then put your focus on the tactical cycle to help you determine your projected ROI.

What is the Glide Path?

Lastly, we want to look at the glide path. Think of it like landing a plane. It needs to slow down and glide as gently as possible onto the runway, rather than crashing in at full speed. Your exit plan needs to be the same. It’s difficult to go from 100% ownership and commitment to your business to selling it the next day and leaving forever. You need to make a gradual, strategic transition for your own financial well-being and that of the company itself. The same is true in handling all major investments. Look for ways to phase out and have a smoother financial transition into retirement.

Calculating your wealth gap is just one important step to take as you plan for retirement and create your business exit plan. The objective is to set yourself up—mentally, physically and, of course, financially—for the next phase in life as you move on from your business. Whether that next phase involves a new business venture or full-on retirement, understanding your wealth gap and knowing how to use it in your financial planning will make a major difference.

For all your business planning, exit planning and general financial planning needs, contact the team at Illumination Wealth today.