The desire for freedom is hard-wired into most entrepreneurs’ psyche — after all, that’s why you started your own GovTech firm in the first place. Although you could have had a cushy office position with a nice salary and benefits, you decided to strike out on your own, forgoing job security in exchange for independence.
However, even running a successful business doesn’t mean that you’re entirely free from problems and stresses. Achieving total independence means selling your firm and generating a pool of cash that’s enough for you to fund your retirement lifestyle.
But how do you know whether it’s the right time to sell? Below, we’ll discuss the concept of a “freedom point” for entrepreneurs and how it should impact your decision-making about selling your GovTech firm. This article is the first in a two-part series exploring the question: How do you know if you should sell your GovTech or government contracting firm in the post-pandemic economy?
What Is Your “Freedom Point”?
If you’re lucky, your business may have been so successful that you’ve already passed your “freedom point”: the moment at which the net proceeds from selling your company (i.e., profit minus taxes and expenses) are enough for you to live comfortably and pursue your other goals and ambitions. In Wall Street terms, this is known as being “risk-on” (rather than “risk-off”): a sentiment in which investors assume more risk due to optimism about market conditions.
Many GovTech firm owners are understandably reluctant to sell their business after pouring so much of their time, knowledge, and effort into the company. Yet, at the same time, hanging on to your business for too long is also a major risk, endangering the freedom that you’ve been working toward for years.
Although estimates vary, as much as 50% to 80% of the average entrepreneur’s net worth can be tied up in the business itself, rather than in other investments. But this violates one of the golden rules of investing: diversify. Keeping a majority of your portfolio in just one or two assets is much riskier than spreading it out across a variety of investment vehicles.
Regardless of how strong the current market conditions are, economic cycles and downturns are inevitable. Even after you’ve reached your personal freedom point, it’s possible that your business will drop in value, putting you beneath this threshold once again.
There are other risks to consider as well for owners of federal contractor businesses. Exit strategy advisors call these complications “the four D’s”:
- Divorce, especially if you and your spouse work in the same business.
- Departure of you or another of the company’s partners.
- Disability that makes it difficult or impossible for you to continue working.
- Death that burdens your beneficiaries with a company they don’t know how to run, jeopardizing its business value.
To avoid losing out on this precious opportunity, GovTech firm owners need to calculate their freedom point so that they know when they can safely sell their business.
7 Steps to Calculating Your Freedom Point
In this section, we’ll go over the seven steps to calculating your freedom point — i.e., the amount of money you need to generate in order to retire comfortably.
1. Estimate the income you need.
Each GovTech firm owner has their own freedom point. If you have a taste for fancy cars and world travel, your freedom will be higher than someone else who already owns their own home and enjoys life’s simple pleasures. It’s better to overestimate here, since you can always scale back later if necessary.
2. Multiply by 33.
The “4% rule” is a rule of thumb that generally allows retirees to withdraw 4% of their nest egg each year without running out of money. For maximum security, we suggest a conservative 3% withdrawal rate. Take your estimated annual income from step 1, and multiply it by 33 (if you’d still like to withdraw 4%, multiply by 25 instead). The result is the total dollar amount that you’ll need for a stress-free retirement.
3. Calculate your wealth outside your business.
Of course, your GovTech firm isn’t the only asset in your portfolio. Add up your sources of wealth that you could sell relatively easily (e.g., stocks, bonds, or commercial real estate), and subtract any debt on these assets. Don’t include your primary residence, since you’ll need a place to live in retirement.
4. Get a valuation for your business.
Getting a business valuation could be an even smarter decision than chasing down your next government technology contract. This means estimating what the shares in your business could be worth to a buyer. Speak with your Certified Value Builder™ or find one here.
5. Estimate the cost of selling your business.
Taxes, lawyers, business brokers, and M&A professionals can all be significant expenses. These costs need to be subtracted from the amount you would receive when selling your GovTech firm.
6. Add any long-term business debt.
Finally, long-term debt needs to be considered and subtracted from your business valuation. Many buyers will require this debt to be cleared or paid off by the time you hand over the reins.
7. Calculate your freedom point.
Based on the previous steps, we have a simple formula for calculating your personal freedom point:
- Estimate your desired annual income in retirement and multiply by 33.
- Take the value you would receive from selling your business and subtract M&A costs and long-term debt.
- Add the value of your other assets such as stocks, bonds, and real estate.
If the value in step 2 is greater than the value in step 1, you’ve already reached your personal freedom point.
Calculating your freedom point is a crucial process for any GovTech entrepreneur thinking of selling the business. So what should you do once you’ve determined that you’ve actually reached your freedom point?
The next article in this series will address exactly that question. In the meantime, to explore these topics in greater detail, check out our white paper, “Selling Your GovTech Firm in the Post-Pandemic Economy.”