What is this essential but elusive number? Quite simply, it is the amount of money you need to sell your business for so that, when invested, it provides all the capital and income that you and your family will need for the rest of your life.
When I was young, we played tennis in the back garden, especially during Wimbledon fortnight when it seemed the whole world stopped to watch the events unfolding in London SW19. The only problem with the matches I had with my siblings was the lack of a tennis net or court markings and therefore no way to keep an accurate score.
Our garden tennis matches usually ended in heated disputes over what shot was ‘in’ or ‘out’ and what backhand smash would have hit the net, if we had had one. Our inability to keep a running tally of who was winning, who needed to score more points and when the match was actually over was a source of huge frustration and many a tennis racket ended up being thrown into the bushes in anger.
Since those days I have always felt the need to have a method of checking in to chart progress across a wide range of activities, from how long it takes to run around the local park, to the number of steps walked in a day or hours slept in a night – thank you Fitbit and Apple Watch – right through to key business metrics and data within our firm.
It seems strange to me that so many entrepreneurs do not spend the time to work out the most important number in their business and keep a very close track of progress towards it: the Entrepreneur’s Magic Number.
If you don’t drive your business, you will be driven out of business
Capital works with a wide range of entrepreneurs and their professional business partners such as accountants and lawyers. All business owners know that there is a huge array of important numbers which need to be measured: sales, growth, profits, gross and net margin and so on. In fact the numbers game never stops. The classic saying is that turnover is vanity, profits are sanity, but cash is king.
This is fine for the day-to-day and year-to-year aspects of a business, but in reality it’s a case of not seeing the wood for the trees.
Your business may provide you (and possibly your partner and children) with a good income, bonuses, perks such as healthcare, insurance, pensions and a high-quality company car. Entertaining clients and travel may also be included.
Life after the sale
When you sell your business, the trappings of the business go as well. You exchange everything the business awarded you (and let’s ignore the important factors like social integration, friendships and the like) and in return you get an after-tax payment, plus a lot of professional fees which need to be paid.
That big bank statement? That’s it now. You are on your own. With interest rates at or near their all-time historic low point, your capital sum is already at risk from annual inflation. And six months after the sale, bank protection falls to £85,000 in the event of a default.
Your capital has to replace all the incomes, the medical cover premium, the pension contributions and the cost of running a car. If you lived well as a entrepreneur before, you won’t want to fall from grace now.
It is possible to earn 2% on cash, so for every £10,000 of interest you will need £500,000. And this is before tax is taken off. If your pre-sale income was £100,000 a year, it will take £5m to deliver it without spending capital.
Of course, this oversimplified example doesn’t take any account of variables such as tax, inflation or investment returns, and a rather more sophisticated calculation is required to get closer to the real ‘magic number’.
Rehearsing the future
Modern financial forecasting software (at Capital we call it FutureMap) allows you to model multiple, distinct scenarios (can you afford a bigger house? What about a holiday home in Turkey? Can you afford to help the kids on the property ladder. What about a trust for the grandchildren? Or helping your favourite charity?). For most entrepreneurs whom we help with FutureMap, it’s a fun and engaging experience.
The process has been referred to as ‘rehearsing the future’ and can help you get as close as possible to putting a figure on the price of total financial freedom and independence for you and your family. Once you have enough capital that can generate the income needed to sustain your perfect lifestyle, then working is completely optional and you have control over how and with whom you spend your time – bliss! That’s why you are working so hard.
As a business owner the key is to identify the current fair value of your business if you were to sell it now, compare it to the desired magic number figure and establish if there is a gap, and if so how big is it?
Using the example above, you might need a sale value of close to £7 million so that after tax and fees you could end up with £6m. This will generate a gross income before tax which may be close to the numbers needed.
But your corporate finance advisers have explained that the business today is worth just £4.5m.
Your challenge then is to focus on the techniques, strategies and tactics that will be needed to get the value of your business to £7m or more. What are your options? Increase your prices? Diversify into new markets, trim costs, increase sales and profits, invest in a new IT system or sales team?
Once you are crystal clear on what the score on the door needs to be, you can then apply relentless focus and drive on moving you and your firm closer and closer to the finish line every month and every quarter.
Once you get there, you may decide not to sell after all as you're having so much fun and really enjoying the cut and thrust of a reinvigorated entrepreneurial life. At that point, you may decide to reset your magic number and ‘go again’; after all, it's your game and you can make the rules.
If you keep score and never lose sight of your goal, then the freedom, independence and lifestyle options that will be created for you and your family will be well worth it.
If you really want to ace your entrepreneurial adventure and business life, make sure you always know your magic number and keep it front and centre at all times.
More balls, please.