Words: Greg Lewis
I talk to a lot of business owners who have worked in their business their entire life and when the time has come to retire or transition out of the business they ask the same question, “What is my business worth?”
My answer to all of them is “It Depends.” Let me share a personal story. We raised three daughters on a horse farm when the children were younger. I learned that I could buy high-quality thoroughbred horses for $2500 to $3000 that were bought for $25,000 or more by syndicate owners who wanted them to run for the money on the racetrack.
Hmmm! Why would someone buy a horse then sell it for 10% of what they paid for it? If the horse isn’t winning races the owners aren’t making money, so they cut their losses by selling their investment and buying another racehorse.
Now you may be asking what does this have to do with how much my business is worth? A Lot! Your business is similar to the racehorse. The value of your business is linked to its ability to produce future profits. The amount a buyer is willing to pay for your business will all come down to two things: return-on-investment (ROI) and relative risk.
The lower the risk, the higher the price, and vice-versa. With that being said, if the racehorse were winning races and your business is consistently making profits, I would have had to pay more money for the horse and your buyer will have to pay you more for your business.
How much is your business worth? Depending on your age, you may remember your Dad horse-trading with someone on the sale of real estate, businesses, etc. You know, how much is the seller willing to take and how much is the buyer willing to pay. Well, today it’s no longer a speculative question or one that should be answered with a “ballpark” guess. Attaching an accurate valuation to a company is a critical part of the ongoing business strategy.
Exit Planning is a Process and NOT an Event.
If you are planning to sell or transition your business sometime in the future, it is a great idea to set a baseline value for the business and develop a strategy to improve the profitability (to increase the value) as an exit strategy. This is where an independent valuation by a professional valuation firm is so important. You have to know where you are before you can see where you are going.
A valuation is not just for selling your business. If you are in a partnership or LLC, a buy/sell agreement between principals can help to avoid future disputes. A mutually agreed-upon value is the starting point for an agreement that is acceptable to all parties.
If you are in a family business, a buy-sell agreement is a contract entered into by the owners of a family business to define the owners’ rights and obligations upon the occurrence of certain “triggering” events. These events could be any number of life scenarios including death, disability, or transition to the next generation that would cause the owners to want to have pre-determined, legally enforceable ways to deal with the situation.
Let’s say you want to create an Employee Stock Ownership Plan (ESOP). You will need a valuation to determine the Annual Per Share Value of the ESOP. In order to meet ERISA and IRS requirements, shares of Employee Stock Ownership Plans must be valued by an independent valuation expert on an annual basis to establish a fair stock price.
Other Reasons to Have a Valuation
Funding – When negotiating with banks, venture capitalists, or other prospective investors, an objective valuation will help in raising capital.
Gift Tax Planning – Avoid problems with the IRS by having an accurate, defensible, and documented value.
Estate Planning – Nobody wants to leave their heirs with the burden of paying heavy taxes on a business that was undervalued. Knowing the value of your business is necessary in order to adequately fund a future estate tax liability.
Opportunities to Reevaluate Your Business NOW
We’ve just finished up a crazy 2020. All indications are that the global economy will continue to heal from the coronavirus pandemic. Whether transition planning is in your plans or not we want to encourage you to have a plan. This recovery could last for years!
Take time to do due diligence on your business. What are your weak links? Look at your P&L. What areas can you improve? How can you come out stronger?
- Triage your Business – Categorize your desired outcomes and goals. Create the processes that will support them based on their relative importance to achieving your stated measurable goals or outcomes.
- Focus on your Balance Sheet – The balance sheet is an important financial statement that should be interpreted when considering an investment in your company. The balance sheet is a reflection of the assets owned and the liabilities owed by your company at a certain point in time. The strength of a company’s balance sheet can be evaluated by three broad categories of investment-quality measurements: working capital, or short-term liquidity, asset performance, and capitalization structure. Capitalization structure is the amount of debt versus equity that a company has on its balance sheet.
- Build up Liquidity for the next 12-18 months
- Build or Strengthen Relationships with your Current Lender
- Work Closely with your CPA
- Look at Supply Chain Vendor Relationships for Cost Cutting Opportunities
- Reorganize your Workforce
- Finally, Look for Ways to Create more Value
There is no simple answer to the question, “What is My Business Worth?” To get to where you are going, you need to know where you are today. Once your business’ valuation has been established, set new goals to increase the company’s value over the next year. Then each following year, set time aside to compare the previous years’ valuations to measure growth, losses, and notice where room for improvement can be. Knowing what every component of your business is worth is invaluable information for business owners to have. From transition planning, leadership succession, strategic planning, organizational management, and executive coaching, our team is prepared to help your family THRIVE, your business to Perform, and working together you can create a lasting legacy. To ask questions about how to successfully transition your business, call us today! If you want to talk. We’ll listen!!
Greg Lewis is a family business advisor with The Tennessee Center for Family Business (www.tncfb.com) located in Nashville, Tennessee, and the host of Family Business Today podcast. His wife, Jennifer, is President and a family counselor. He can be reached at firstname.lastname@example.org or 615-513-9028.