What is my business really worth? We hear that often, and it’s actually the best question a business owner should be asking as they are doing long-term planning.
The short answer to “What is my business worth” is “it depends on many factors.”
For a business to have value, it must be able to exist, separate and apart from its owner. The term for that is “transferable value.” The business must have systems and processes that allow it to operate without the owner being involved in every decision and process critical to the daily operations. In short – the owner must be able to take a week off on vacation and have a business when he or she returns.
The main reason to engage in long-term planning is to set the timeline to monetize your equity in the business – also known as Exit Planning. Having an estimate of value is critical to that process for several reasons:
- Establishes your starting line and distance to the finish.
- Business value is critical to financial planning.
- Provides important tax information for the owner.
- Establishes the type of buyer the owner should target.
- Provides an objective basis for employee incentive plans.
An “estimate of value” is not a full-blown appraisal, and costs much less than a complete business appraisal. It is sufficient for planning purposes, but not for estate, tax, or divorce purposes, when a full-blown business appraisal would be required.
- Business value - there is a saying in business that is very true: “Knowledge is power.” Having a realistic idea of business value is critical to business planning. However, the key data point is not the top line, most probable selling price, but the bottom line. What are the net after-tax proceeds that the owner will receive from the “most probable sales price.”
- Financial planning - the business owner needs to know “How much will I need from the sale of my company to maintain the lifestyle I want for me (and my family) in retirement?” That income amount will need to be compared with the income generated from the estimated net proceeds computed in step #1. Will it be sufficient, or is there a gap?
- Tax planning - Taxes can take a huge bite out of your sale proceeds. Tax mitigation strategies often take years to implement, so it is critical to meet with your CPA well before your exit, to allow time to implement tax savings ideas. The net after-tax proceeds are the key data point in the planning process and we don’t want the IRS to be at the head of the closing table!
- Types of buyers - there are two basic types of buyers: financial and strategic. The business owner needs to know the multiples of EBITDA that each type of buyer will pay, as well as the probable transaction structure. Business sales are not always “all cash.” A transaction can consist of cash, seller note, and possibly an earn out, and the buyer might want the seller to maintain some equity post- closing in a recapitalization transaction. Understanding the type of transaction preferred by each buyer type gives the owner the ability to target the type of buyer that best achieves their goals. An M&A professional can help with this analysis.
- Incentive plans that both motivate and “handcuff” employees can both increase profitability of the business and the value of the business to a buyer. There are several tools that an owner may use, such as a “stay bonus” for key employees, that give the buyer comfort that the management team will remain intact after closing. As with tax planning, these tools need to be implemented well before marketing the business.
In summary, few business owners want to spend money on something they don’t need, and a full-blown business valuation costing several thousand dollars is not needed for this process. An “estimate of value” is limited in scope, and not appropriate for divorce or estate planning, but sufficient as a starting point for the business owner’s year-to-year and exit planning.