Business Exit Planning: The Three Financial Gaps Every Business Owner Should Measure

Executive Summary 

As a business owner, you’ve likely spent years growing your company while also thinking about what comes next. Whether you’re planning to sell your business, transition ownership, or simply understand where you stand today, having objective financial benchmarks can help you make more informed decisions.

One framework that can provide that perspective is the Rule of Three. By evaluating your wealth gap, profit gap, and value gap, you can better understand where your business stands today and identify opportunities to strengthen both your company and your long-term financial future.

What you will learn:

• How to calculate your wealth gap and determine the financial target your business transition needs to support.
• How to evaluate your profit gap by comparing your business’s profitability to industry benchmarks.
• How to measure your value gap and identify opportunities to strengthen your company’s long-term value.

Why you should read this:

• Better understand your financial readiness for a future business transition.
• Identify opportunities to strengthen your company’s profitability and long-term value.
• Use objective financial benchmarks to guide future business and personal planning.

Thinking Through the Three Gaps for Business Owners

A successful business transition balances your personal, financial, and business goals. To help achieve this balance, it’s highly beneficial to identify three specific financial measurements. By understanding these numbers, you can engineer a strategy to close the distance between where you are today and where you want to be tomorrow.

Step 1: Closing the Wealth Gap 

Your wealth gap is the difference between your current personal wealth and the total financial resources you need to comfortably live the life you desire after exiting your business. Finding this number ensures your business transition will fully support your next chapter.

Part One: Establish your net worth goal by picturing your ideal future lifestyle. This can involve traveling, starting a foundation, or enjoying a quiet retirement.

Part Two: Calculate your current personal net worth. When doing this, intentionally exclude the value of your business, as it is not easily converted to cash and you may choose not to sell it entirely.

Part Three: Subtract your current personal net worth from your overall net worth goal. The resulting number is your wealth gap, which becomes the concrete financial target that your business transition needs to fund.

Step 2: Closing the Profit Gap 

The profit gap represents the earnings you might be sacrificing by not operating at a best-in-class level for your specific industry.

Part One: Determine your company’s actual profit. This is usually measured as Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA), and it should be adjusted for any owner-specific discretionary expenses or one-time events.

Part Two: Research the best-in-class profit margins for businesses at your current sales volume within your industry.

Part Three: Subtract your actual, adjusted profit from the best-in-class profit. This reveals your profit gap, highlighting the specific operational opportunities you have to improve your daily cash flow and overall efficiency.

Step 3: Closing the Value Gap 

Your value gap is the overall business value you may be missing out on by not operating at the level of top-tier competitors. Buyers generally pay premium multiples for highly efficient, independent companies.

Part One: Calculate what your business would be worth if it operated at a best-in-class profit margin and sold for a best-in-class market multiple.

Part Two: Conduct an objective valuation to find your company’s actual current value, which is based on your existing profit and an average market multiple.

Part Three: Subtract your current value from the potential best-in-class value. Closing this gap often involves decentralizing yourself from the business, documenting your processes, and actively strengthening your leadership team.

Next Steps 

Evaluating your business through the analytical lens of these three gaps provides you with a grounded, factual starting point for your eventual transition.

What you learned:

• The Rule of Three involves calculating and managing your wealth gap, profit gap, and value gap.
• Your wealth gap determines the exact financial target your business transition needs to cover to support your future.
• Your profit gap compares your current earnings to the top-performing businesses in your industry.
• Your value gap shows how much additional overall business value you can build by improving your operations and multiples.

Now what:

• Determine the annual cost of your ideal post-business lifestyle to establish your net worth goal.
• Calculate your personal net worth, making sure to exclude the value of your company.
• Work with an independent professional to assess your current, adjusted profit and overall business value.
• Compare your numbers to industry benchmarks to clearly identify your specific financial gaps.

Disclaimer: This is not formal tax, finance, or business advice. Please consult with a professional to learn more. This blog was created with the help of AI and edited by humans. Factual content is believed to be from reliable sources, but cannot be guaranteed. Laws relating to the content discussed may have changed since the article was written. FWP does not provide tax or legal advice. Speak with a qualified professional prior to implementing any strategies or ideas discussed.

Contact an Advisor 

You don’t have to navigate this alone. Every business exit is different. We want to get to know you, your business, and give you a sense of what it’s like to collaborate with us. Contact an advisor today to help you build a plan that protects your life’s work.