Knowing when to diversify company assets is crucial to a successful business strategy.
Embarking on the journey of business ownership requires not just passion but also strategic foresight. In this article, Simon R. Barth, from ONEtoONE Corporate Finance Colombia, unravels the Rule of 130–an indispensable compass for entrepreneurs.
Join us in exploring when and why you should contemplate selling a portion of your business to embark on asset diversification.
What is the Rule of 130? When to diversify company assets?
The Rule of 130 involves calculating how much your company’s value contributes to your personal net worth. This percentage, converted into a number, must be added to your age. If the resulting value is greater than 130, it is advisable to start diversifying.
This is the breakdown of the Rule of 130 equation:
Age + percentage of net worth tied to the business
A hypothetical case: applying the Rule of 130 to diversify company assets
Let’s take the hypothetical case of a businesswoman called, for example, Mary. She is 48 years old. For the last 15 years, she has been developing her own construction business. Today, she owns the following assets:
To simplify, we will assume that:
- She has no personal debt.
- The 10 million dollars in equity value is the result of subtracting a 5 million financial debt from the company’s 15 million enterprise value.
As you can see, 84% of her personal assets are tied up to the construction company, which has generated most of the other wealth and provides a stable income and good quality of life.
What would happen if the company went bankrupt for not diversifying assets?
Mary could end up losing the company and the other assets she has accumulated over her entire life.
It’s essential to note that a prevalent practice among small and medium-sized firms involves obtaining bank loans supported by guarantees tied to the business and personal guarantees from the owners.
Now, as you know, construction is a risky business and is subject to market cycles, supply and demand, and interest rates.
In the event of a market contraction or a major project failure for any reason, Mary could lose everything.
Let us apply the Rule of 130 in this case. We need to add Maria’s age, 48, to her personal wealth tied to the business, which is currently 84%:
48+84=132
The result is bigger than 130, so it is advisable to consider selling a stake or completely exiting the business to diversify her risk.
Options to diversify company assets
Mary has a number of options to diversify risk.
1. Searching for a strategic buyer
Una alternativa para logar este objetivo es buscar un comprador estratégico, como otra empresa de construcción dentro del mismo país o una entidad extranjera, para explorar una estrategia de salida.
An alternative is to look for a strategic buyer, such as another construction company within the same country or a foreign entity, to explore an exit strategy. Normally, this buyer has the most synergies and will pay more.
Why would they buy this company? They could be aiming to expand their own business by acquiring sales and getting access to the expertise, brand reputation, human workforce, and existing project backlog or pipeline.
2. Searching for a private equity fund
Another alternative would be to look for a private equity fund interested in growing the business. They could do a cash-in and cash-out operation.
- The cash-in approach involves the company issuing shares to the investor to raise capital. This capital will be utilized to boost the company’s growth. Also to increase future cash flows for all shareholders; this operation will partially dilute Maria’s stake in the company.
- The cash-out approach, which consists of selling Mary´s stock, will provide her with some liquidity to buy additional profitable assets, like rental warehouses, bonds, or index funds. This strategic move ensures that, if the company doesn’t survive, she secures enough passive income to live comfortably for the rest of her life and even create what is known as generational wealth.
Getting advice to protect these assets from creditors and using corporations, family trusts, private interest foundations in other jurisdictions, or other mechanisms is crucial.
Advantages of private equity
Mary has now diversified her risk and found an intelligent partner with significant connections in the financial world to leverage more projects for the company. She can now work for another eight years, until her retirement age, without bearing the entire responsibility for the company’s outcomes.
The PE funds usually exit their investments within 5 to 8 years. As Mary remains a minority shareholder of the company, she will probably sell her stake before retirement and, therefore, secure a higher price for her shares. Several times, I have seen second liquidity events in which the minority stake surpasses the price or the proceeds of the majority stake initially sold.
With some investors, you can do a combination of a cash-in and a cash-out, providing liquidity for both the business and the owner at the same time.
This is a theoretical example based on real-life examples. Usually, PE funds target large transactions, but I wanted to demonstrate this with simple figures.
The Rule of 130 and the safety of diversifying assets
In a nutshell, if you are a successful business owner, apply the Rule of 130. Add your age to the percentage weight of your business in your net worth. If the result is greater than 130, consider seeking a strategic or financial partner.
This approach can help you:
- Ensure your family’s financial freedom.
- Reduce the personal risk associated with having most of your assets tied to a single business.
Remember to get the best financial and legal advisory to execute this path.
*Note: The rule of 130 was introduced by the best-selling author Adam Coffey in his book “Empire Builder: The Road to a Billion“.This author has been a CEO for 21 years in 3 multi-billion dollar companies. He has bought more than 58 businesses in his roll-up strategies and successfully exited some of them, creating a lot of value for his shareholders.
About the author
Simon R. Barth, Partner of ONEtoONE Corporate Finance Colombia.
Simon is a Professor of Finance, Board Member, and Investment Banker. Master in Finance from Universidad de los Andes. Certificate in Advanced Valuation with High Honors from NYU | STERN. Certified in Negotiation at Harvard Business School and certified in Real Estate Investment Strategies at Columbia Business School. He is an expert in the valuation, merger, and acquisition of companies.
Strategic planning is essential for the success of a business. If you need advice for your company, contact us now.
