Business owners are often disheartened by a professional estimate of the potential value of their businesses.
In my years of advisory experience in mergers and acquisitions, I have met hundreds of owners that are ready to sell for a multitude of reasons — retirement, owner fatigue, inability to service debt, etc.
Many have built their businesses from the ground up and are emotionally attached to them.
Most have an end game in mind that entails cashing out to fund a comfortable retirement; however, objectivity is not necessarily at play when they imagine their business’ value.
The truth is that it is far too late to be considering the true value of a business for the first time when one is ready to sell.
I advise every business owner to get an official business valuation early in their company’s growth stage, and follow that with the development of a business optimization plan well in advance of considering a sale.
I also recommend commissioning a new formal valuation periodically, which can deliver the knowledge, power and ability to demand a much larger payout at closing.
Writings by respected valuation experts such as Shannon Pratt, Rand Curtiss and James Hitchner support this philosophy.
Business valuation is an analytical process that determines the potential value of a business at a point in time.
Some of the steps in the business valuation process are:
- Determining the purpose of the valuation
- Choosing valuation methodology
- Analyzing and recasting financials
- Compiling and reviewing industry data
- Identifying market comparisons
- Developing capitalization rates
- Quantifying tangible and intangible assets
- Estimating future fixed asset capital expenditures
- Developing working capital requirements
- Quantifying marketability and control discounts
Business optimization entails an independent analysis to identify inhibitors of maximum profitability, growth, stability and sustainability.
Items commonly addressed during business optimization include:
- Revenue stream
- Target market health
- Revenue and profit concentration
- Gross and net margins
- Operational processes
- Quality control
- Organizational structure
- Talent concentration
- Strength and depth of management teams
- Financial preparation and accounting practices
- Owner’s role in the business.
Ideally, an owner will use a business valuation as a benchmark and then will develop a business optimization plan to grow the value of the company beyond that.
The combination of these two exercises paves the way for a business owner to bring to market a company with much greater value than previously possible — a value potentially greater than even they had envisioned.
Value Is Point-in-time Specific
A valuation commissioned a year ago doesn’t reflect the true value of the business today; owners should monitor value on a regular basis and optimize it accordingly.
For example, assuming a business owner wants to sell his or her company in five years — any unforeseen or incalculable circumstances notwithstanding — I would recommend establishing a three-point, time-specific plan for valuation.
The following approach applies to the aforementioned five-year plan:
1. Year one of the valuation process
Engage a certified valuation expert to complete a thorough business valuation and establish a benchmark value.
After the initial valuation is completed, hire a business optimization expert to help map out the next five years in order to achieve the returns forecasted in the valuation.
2. Year three of the valuation process
Conduct a new valuation to take into account market fluctuations, asset variations and income changes, as well as competition, economic conditions and any internal company reconfiguring.
After the follow-up valuation is performed, determine the best course of action needed to continue growing the value of the business.
3. Year five of the valuation process
One year to six months prior to marketing the business for sale, complete a final valuation, using the data compiled in the three-point valuation process as a tool to support the asking price.
Oftentimes, the actual sale price of a business will be much higher than appraised value.
The merit of the formal appraisal is that it sets a realistic threshold upon which to build during negotiations.
Time And Money Well Spent
Business owners may be apprehensive to take on the dual valuation/optimization approach due to the time and expense incurred.
The outlay should be viewed as an investment rather than an expense, as it usually results in a higher sale price — with the added incentive of reduced deal fatigue for both the seller and buyer.
We see both sides of the coin at Pursant and, through our experiences with numerous types of clients — seek to ensure that the sale of your business is as profitable as possible.
We have witnessed 20-plus-year-old businesses that have not properly prepared for a walkaway sale with barely enough money to pay off their outstanding debts and taxes.
These sellers are often beholden to the new owner for a salary or have to seek employment outside of their traditional market segment or sector due to the restrictions of a non-compete agreement.
On the other hand, the companies we see that invest in valuation and optimization typically have very different outcomes.
The owners of these companies frequently walk away from their businesses with more money at closing and an increased peace of mind, comforted by the notion that they can seamlessly transition to retirement.