3 Things to Consider When You Hit “The Freedom Point”


When was the last time you calculated the percentage of your net worth tied to your companys value? 

 When you started your business, its value was probably negligible. Unless you purchased or inherited your company, it wasnt worth much when you opened your doors, but over time, the proportion of your assets tied to your business may have crept up.  

 Lets imagine a hypothetical business owner named Tim, who starts his company at age 30. He has a little bit of equity in his first home and a small retirement fund. When he starts his business, its worthless, so it doesnyet factor into Tims net worth calculation.  

 By the age of 50, Tim has built up $600,000 worth of equity in his home, his retirement nest egg has grown to $400,000, and his business has blossomed and is now worth $4,000,000. Tims company has crept up to represent 80% of his net worth.  

 Tim knows the first rule of investing is to diversify, which he is careful to do with his retirement account. Still, he has failed to achieve overall diversity given the success of his business.  

 Whats more, he may have unknowingly passed something called The Freedom Point, which is when the net proceeds (i.e., after taxes and expenses) of selling his business would garner enough money for him to live comfortably for the rest of his life. Your lifestyle determines your Freedom Point, but when you pass it, its worth considering the risk youre taking.  

 If this pandemic has taught us anything, it is that nothing is for sure, and a thriving business one day can turn into a struggling company overnight. When your business makes up most of your net worth and selling it would garner enough money to retire, theres no financial reason to continue owning your business. You may enjoy the challenge, the social interactions, and the creative process of building a business, but keeping it may be unnecessarily risky.  

 When youve crested the Freedom Point and want to diversitybut still dont want to retireyou have some options: 

  • Sell a Minority Stake: In a minority recapitalization, you sell less than half of your shares. Often sold to a financial investor such as a private equity group, a minority recapitalization allows you to diversify your net worth while continuing to control your business. 
  • Sell a Majority Stake: In a majority recapitalization, you sell more than half of your shares to an investor who will most likely ask you to continue to run your business for many years to come. You get to diversity your wealth, keep some equity in your business for when the investor sells, and continue to run your company.  
  • Earn-Out: When you sell your company, youll likely have to agree to a transition period of sorts. One of the most popular is called an earn-out, where you agree to continue to run your company as a division of your acquirers business for a specified period of timeYour earn-out may be as little as a year or as long as seven, but the average is three years. Therefore, if youre past the Freedom Point and can see yourself wanting to step down in the next three to five years, an earn-out may be worth considering.  

Building a successful business is rewarding, but when your personal balance sheet gets out of whack, it may be worth considering the risk you’re shouldering and the options you have for sharing some of it.  

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Pay Less Tax

A great small business tax accountant does more than just measure value, they create it. At CPA4IT our goal is to save you substantially more than it costs you for our services. Over the last 30 years we have developed tax strategies designed to help you keep more of your hard earned money. If you would like to learn how we can help you pay less tax, simply download our FREE Guide to Pay Less Tax.