Dan Reiter, CFP®, CPA
Having a clear understanding of your business’s value is a critical first step in planning for any successful outcome with your business, no matter what your desired outcome may be. Whether you plan on selling your business to a third party for maximum value, gifting it to children, or staying at the helm until you drop at a ripe old age – understanding the true value of the business will help you as the owner make better strategic business decisions, protect both your (and your business’s) financial independence, and more accurately plan for your desired future with better odds of success.
Make Better Strategic Business Decisions
The problem? Most business owners ignore their business’s value, instead often choosing to rely on industry “rules of thumb” to measure the price of their business. Unfortunately, this often leads to a gap between the price sought by the owner and value perceived by a buyer. What is the difference between price and value? In the words of the great investor Warren Buffet, “Price is what you pay. Value is what you get”. This expectation gap will either lead to no deal being struck with a potential buyer, or an agreed price that is far below owner needs.
Are you one of those who plan to keep their business forever? I would still assert that, unless you have discovered and hidden away the secret for immortality, at some point your business will transfer to another party and have a realization event for value. At that point, is it not best for your customers, employees, and other stakeholders that your business lives longer than you do? Would a business that is better run with less risk not be a better gift for your children?
The solution is a valuation engagement that measures value through the lens of a company’s key value drivers. Value drivers are fundamental elements that any company must have to reach maximum value. Various valuation and business experts define these differently. Our firm assesses eight key areas that drive value: planning, leadership, sales, marketing, people, operations, finance, and legal. Often companies will be strong in one, two, or maybe several of these areas. Almost always there are significant gaps or risk factors. These risk factors are, at best, constraints to growth. At worst, they are deal breakers for buyers. At the end of any good valuation engagement, you as the owner should be left with valuable insights into the areas of greatest opportunity for business value improvement and maximization. These insights can help shape your business decisions and where to focus your limited energy, time, and money.
Protect Business Value and Personal Net Worth
Countless businesses and personal balance sheets have been put on the ropes or buried because of what we will call the four “dismal Ds”: death, disability, disputes (partners or shareholders), and divorce. First, if your business does not have a continuity plan or buy-sell agreement in place, start there. A buy-sell agreement is a legally binding contract that describes how your ownership share will be transferred in the event ownership must change hands due to any of the aforementioned events. A well thought-out and professionally prepared buy-sell plan is table stakes in ensuring your business outlasts any of these external risks.
An important component of any buy-sell agreement is how the business will be valued under each circumstance. If you are one of those that do have a buy-sell agreement in place, do you remember the business valuation or formula used? If you are like many business owners, the valuation noted is inappropriate or outdated. The end result may be you or your family receiving less than the true value of the business, or you paying more than fair value to an exiting partner. A periodic review of the valuation method used in your buy-sell agreement is critical in protecting both the business and yourself from such catastrophic events.
To More Accurately Plan
The first step in creating your desired future is to envision it, to design it in your mind. If you do not understand your starting point, this becomes a fruitless and impossible task. If your doctor told you your ideal body weight to add the most years to your life, how would you know how to get there if you first did not know what you weigh today? In the words of author Stephen Covey, to maximize your effectiveness in pursuit of any goal you must first “begin with the end in mind”.
In our work with business owners, helping them understand what their business is worth today coupled with their other goals such as how long they want to maintain ownership and to whom they wish to transfer, all serve as the building blocks for helping the owner envision their future. Sometimes, in our analysis we uncover that the business may have sufficient value today to meet their long-term goals. More often, though, we identify that there is a “gap” somewhere between what they want, and what their business will realistically return to them after taxes and selling costs.
Quantifying your own personal “gap” is the first step in closing it. The good valuation analyst should be able to give you specific ideas of what changes to make in your business and quantitatively explain their impact. Further, working with a fiduciary financial planning professional that understands your full financial picture can help illustrate options to help you make the most informed decisions based on your unique priorities and level of importance for each. Ultimately, having a business valuation puts you as the owner in far better control of your own destiny and ability to maximize your outcome.