If you own a business, odds are that it is your single largest asset. This has profound, long-term implications for you and your family’s financial well-being.
Every business owner should develop a clear and accurate understanding of the value of his or her business. I often find myself discussing this topic with valuation expert Cathy Durham, a shareholder of Madison-based Capital Valuation Group.
Here are Cathy’s five reasons for determining the value of one’s business:
- First and Foremost a Business Valuation Allows You to Determine if Your Business is Transferable. Not all businesses are actually transferable or saleable. The first step a business appraiser will take is to determine whether a business has value to a buyer beyond the value of its tangible assets. This question arises specifically when the business’s success and continuation is dependent on the owner and the business’s ability to generate sufficient profits to provide a return on investment are limited or non-existent. Most businesses can become transferable but it takes time, planning and investment.
- A Business Valuation Enables You to Have a Realistic, Supportable Value Conclusion Allowing for Meaningful Planning or Negotiation. Business owners often think the value of their business is higher than it actually is. This can be based on only considering its historical performance and applying a multiple to get a “back of the envelope” result that does not consider future changes. Privately owned businesses are dynamic in that they are growing, shrinking, hiring, firing, re-investing in capital expenditures, funding working capital needs, etc. Too often business owners assume the business is worth the number they need it to be worth in order to retire. Unfortunately, that is not going to have a happy ending.
- A Business Valuation, if Done Accurately, Will Identify the Drivers of Value in the Business. Business valuation needs to include more than just a calculation of numbers on your income statement. There are a significant number of qualitative factors that are nowhere on your income statement that result in increased (or decreased) value. Identifying and understanding these factors and the impact they have on value for your company, enables you to implement strategies to increase the value over time -- before it’s time to sell.
- A Business Valuation Allows You to Track Your Largest Asset and Plan Realistically for the Future. A business is generally the owner’s largest asset, typically by a significant amount. Realistic retirement planning depends heavily on the value assigned to the business. Just as one would not go 20 to 30 years without looking at the value of one’s 401(k) account, a business owner should understand the current value of the business, or the value of his or her ownership interest in a business if there are partners. Further, business valuations completed over a period of time inform the owner whether the value of that business is increasing or decreasing.
- Business Valuations Assure Buy-Sell Agreements that Will Work. As they say, “never get into business with others without first defining how you will get out of business.” If you don’t own 100% of your business, a Buy-Sell Agreement is possibly the most critical legal document you will have drafted. Included in the well-done agreement are the valuation provisions for each of the six triggering events that could occur, not just death and disability (resigning, termination with cause, termination without cause and retirement). A business valuation allows owners to define their intent under each of these circumstances by considering the impact on value. This enables owners to define “fair” before they know which owner or event will trigger the agreement.
Tip: Not all business valuations are created equal. You may encounter calculation-based valuations. Calculations simply use a multiple of earnings, but that assumes the Company’s future results will be exactly the same as past results--no real growth or decline. This is not a realistic assumption for 99% of privately-owned businesses.
Remember…the devil is in the details; therefore, a meaningful business valuation will include comprehensive modeling that analyzes past performance and trends, projects the Company’s future business plan, considers qualitative factors that can increase or decrease value, as well as market and economic trends.
Price is what you pay. Value is what you get.
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