Conservatively estimate the likely investment return you anticipate from the sale proceeds.
This blog is the last discussion of three major headwinds that challenge owners in crafting successful exits from their companies. The first described the difficulty of growing companies in a stagnant economy. The second blog quantified how higher tax rates effective January 1, 2013 generally reduce net proceeds by five to 10 percent. Today, let’s look beyond the closing table and prognosticate what return you can expect from the sale proceeds.
As a Boomer owner I’m beginning to believe that we lived in a quasi-fantasy land for much of our business ownership lives (approximately 1975 to 2000). Why? Consider two major barometers for investment income during that time period. The S&P 500 had an average return of 16.88 percent per year. Let me repeat, from 1975 to 2000 the average S&P return (dividends included) was 16.88 percent per annum. Contrast that with this century: From 2000 through 2013, the average annual S&P 500 return (including dividends) was 2.324 percent.
The second benchmark is the average yield on 10-year U.S. Treasury bonds. From 1975 to 2000, the yield was approximately eight percent (8.37%). During the past six to eight years? Approximately three percent (3.78%).
“The yield on the benchmark 10-year Treasury note is just under 2.2 percent, compared with more than 6.5 percent, on average, since 1962, according to quarterly Bloomberg data. And bond investing is likely to remain challenging for years to come. Investors may face a double-whammy — low yields now and the prospect of significant losses as yields rise.” [1]
It is not surprising that so many of us of a certain age consider six to 10 percent to be a “reasonable” return on the investment of our sale proceeds. That’s what we are used to! That’s what is was during the years we started and grew our business.
But that’s not the case today. There has been minimal growth in the stock market since 2000 and bond rates have plummeted to less than half of what they were just a few years ago. Of course, we can hope (and I do) that the stock market and investment returns will grow significantly in the future. They might. Or we could experience another “Great Recession” and watch stock prices fall 30 to 40 percent and deflation emerge which will lower the already low bond rates to something uncomfortably close to zero. Who knows?
But I do know this: I’ve represented a few former owners whose investments portfolio didn’t perform as anticipated, forcing them to return to work. They were not happy. But at lease in those cases the owners were still in their 40s or 50s and capable of restarting their business lives. Most Boomer owners today are older and returning to work in five or 10 years would be not only unappealing, but likely undoable. My suggestion is that you conservatively estimate the likely investment return you anticipate from the sale proceeds. I know I’m not planning to return to work once I exit and I’ve never met a business owner who even considered the possibility (much less the necessity) of going back into the arena because they had run out of money.
So what should you do? What assumptions on the future investment climate should you make? Today many financial advisors estimate a three to four percent income on liquid funds as a safe and reasonable return for their retired clients.[2]
If you do take a reasonable, conservative approach, based on the investment climate over this century, it’s likely that your investment return will be 50 percent or so of what you would have expected during the 1980s and ’90s. That means your nest egg needs to be twice the size to produce the same income as in past decades.
Let me add one more consideration. When we are younger and our income is the result of our business efforts, we tend to invest the stock market. We have time and the expectation of continued business income so we assume the greater risk of the stock market in hope of greater returns. Once we’ve sold our businesses and rely solely on retirement income, we simply can’t afford the risk to our capital and settle for less income generated from presumably lower risk bonds and similar investments.
The Headwinds Trifecta
Combine all three headwinds – a stagnant economy, increased taxes on business income and sale proceeds, and lackluster investment environment — and the implications are clear.
- It will take us longer to grow business value.
- Due to increased taxes, we’ll have less cash after we sell our businesses.
- Our investment returns will be about half of what we have come to expect.
These headwinds matter and they are not going away. It is time to ask:
- If my goal is a successful exit, do I prepare to act now or deal with the headwinds later?
- How do I make my business as headwind-proof as possible?
- Is exiting successfully a matter of doing what I’m doing longer or doing something differently or more efficiently?
Doing something differently
I’ll talk in future blogs about how to actively surmount these headwinds because we can do more than just work harder or take more time to reach our destinations. But time does play an important role. We need time to:
- Start the race today so we can reach my destination on the date we desire.
- Recruit a team of experts who have experience helping other owners in this race.
- Prepare ourselves and our companies for the challenges ahead.
