As a reminder, these seven steps are based off of BEI’s Seven Step Exit Planning Process
Welcome back to our series on exit planning. In our last blog, we talked about the goals and objectives needed to create a successful exit plan. One of those goals was knowing how much money would be needed from the sale of the business to maintain your current lifestyle. That brings us to the topic of this blog: business valuation.
We get it, you’re probably wondering why you need to do this now or how this applies to you. Even if you are not planning to leave the business for quite some time, or think you know what your business is worth, business valuation is an important and crucial step to ensure you have a solid exit plan in place.
Okay, let’s get down to the nitty gritty. For most business owners, their business is their most valuable asset. Sure, you might have real estate, property or stocks, but the main source of income is the business. When you sell the business, you need to know if the cash flow from the sale will be enough to sustain your lifestyle desires. So, how does this business valuation thing work?
First, it is important to note there are two types of valuations that can be done, based on how far away you are from your exit date.
- Thorough Valuation – If you are ready to leave the business now, it is important to have this type of valuation completed. This will establish whether your company can be sold today at its appraised value. Often times, business owners think their business is worth more or less than it actually is. This valuation ensures a correct estimate is in place.
- Calculation of Value – This type of valuation is usually completed annually for those who plan to leave the business, but not for quite some time. This gives more of an approximation of the value, rather than a definitive answer. It helps to determine if the business is on track.
By now, you should be able to determine which type of valuation best suits your needs. However, you’re probably still wondering why you should be doing this. After all, it is your business and you know more about it than anyone else.
Here are some of the top reasons why you should have a business valuation.
- Determine Worth – When business owners are ready to sell, they want to receive the full and fair value from their ownership interest. But how do they know exactly what this price should be? Often times, following casual estimates and rules of thumb does not take into account location, reputation, technology and other important factors that impact the business’ worth. A business valuation, on the other hand, does consider everything. Think: would a buyer purchase a business without knowing how much to pay for it? Probably not, and you as a business owner also need to know how much it is worth in order to determine an asking price.
- Accuracy – After determining what your business is worth, you then have a comparison factor. Once you know how much the business is worth, you can then compare that with your lifestyle desires after the sale, and accurately predict if the business sale will be enough to sustain the lifestyle, or if changes will need to be made to get to this level (our next blog focuses on the idea of increasing value).
- All Factors Considered – Along with including factors such as technology, reputation, etc., the valuation takes into account many different scenarios and options to ensure everyone involved will get the best bang for their buck. This takes into consideration the idea that the value of the business is actually relative and not fixed, meaning it can vary based on many factors. A valuation will take into account the different buying scenarios, such as selling to a third party or selling to an insider. With the value fluctuating, having a valuation done periodically will help keep the value up to date so you have the best idea of just how much you will get from the sale.
- Motivation – Finding out what your business is worth through a valuation can be a great form of motivation for all parties involved, but especially management and employees. Once insiders know where the business is standing and what potential it has for growth, they can often be motivated to work harder to reach these goals. A common way for this motivation to occur is through incentive programs, especially those that link the size of the incentives to the growth in the value of the business.
- What is Fair – If you are selling a business, do you really believe interested buyers will just take your word for it and accept whatever price you say? Probably not. A business valuation can help determine the fair market value of your business, which can then help you develop a fair asking price that doesn’t offend anyone in the process.
So there you have it. A business valuation is absolutely necessary, no matter what stage of the business you are in. It is recommended to start early in case the value needs to be raised, but no matter when you decide to act, the business valuation should never be ignored.