We have discussed the importance of exit planning and why owners should begin the process of planning sooner rather than later. In our last blog we talked about creating a plan for an exit in the same way owners make and follow traditional business plans to build their companies and increase their value. Before an owner can create an exit plan, however, he has to have a solid understanding of the value of his company. Having a comprehensive business valuation done is an excellent way to accomplish that.
What Is a Business Valuation?
A business valuation is a report compiled by a valuation professional that determines by various means the economic value of a business or company. That value will be “the price that a reasonable person would pay to own the future cash flows of a business less any debt owed plus all cash on hand.” To create this report, the evaluator will use financial statements, cash flow models, and market analysis as well as taking into account the unique features of the business itself, including its management and human capital.
Business valuation is not the same as sale price which cannot always be predicted especially when the expected sale is far into the future. Instead, valuation provides a baseline financial understanding for the business owner or owners that allows them to move forward towards a goal. That goal may be the sale of the business, or it may not.
Business owners need a valuation done in a variety of situations. There are many reasons why a business’s value might need to be determined, including a divorce, shareholder disputes, a merger or acquisition, the liquidation of the business, or the drafting of a buy-sell agreement. If the company has any tax or legal issues to resolve, a valuation will need to be performed. If the company wishes to raise debt, the bank it applies to will want to know the value of the business. Of course, valuations are often done as a precursor to a sale too.
Why Does Valuation Matter?
A business valuation is a starting point for action. There may be business owners who have valuations done on their businesses for the simple satisfaction of knowing how much they are worth. If that is the case, they are wasting what a valuation reveals: how strong or weak their companies are. An owner should know how much his business is worth because it’s a snapshot of the past and a vision for the future.
Once an owner knows how strong and how profitable his business is, he is in a much better position to make decisions. A valuation can reveal that the company is in good shape for a sale. Or it might reveal that a sale would be impossible at the present time and why. From there, the owner can take action to fix the problems with the business, installing value drivers and making it stronger and more profitable.
The valuation, then, would act as an initial benchmark and future valuations would be useful to determine if the actions taken were effective. In sum: “The purpose of this estimated value is to track the effectiveness of your strategic decision-making process and to provide you with the ability to track performance in terms of estimated change in value, not just in revenue.”
For many would-be sellers, the initial valuation serves as a reality check, both for the work that they need to do to increase their companies’ value, but also for planning they need to do in their personal finances as they prepare to retire or move on. Too many owners think their businesses are worth far more than a buyer will give them because they cannot look beyond the value their companies have for them personally. They may believe that their retirements will be fully funded by the sale of their companies. In reality, if they continue on without making key changes, they will have to make unwanted lifestyle reductions.
If the owner does decide to sell the business down the line or is approached for an acquisition, having a thorough awareness of the worth of the business can only help during the negotiation process. Being able to demonstrate consistent growth in value over time will attract many more interested buyers and give sellers the necessary confidence to bargain for the best price.
If you are considering selling or transferring your company in the future, having a business valuation done now is a must. Once the business’s valuation has been determined, you will be able to set goals and measure the effectiveness of your actions via future valuations, continuously improving over time. This will put you in an enviable position when the time for future decision making comes, whatever you decide.
If you are unsure of where to begin and would like help with the exit planning process, please call us at Prometis Partners. We have been able to help our clients with every aspect of exit planning from business evaluation to sale, and we can help you too.