A solid business valuation is the first step to any exit planning process
A comprehensive valuation is one of the cornerstones of the exit planning process – before you leave your business, you have to know what it’s worth. Without a good idea of what your business is worth, it is impossible to make informed decisions related to tax planning, estate planning, life insurance, wealth preservation, shareholder agreements and so on. Commonly, the business valuation is the foundation for all other aspects of your eventual exit strategy.
What type of valuation is required? If you are ready to exit your business in the within a year or two, you’ll need more than just a "ballpark" idea. You’ll need a thorough valuation that includes a marketability component – can the company be sold today at its appraised value?
On the other hand, if you are three to five years away from exiting the business, you may not need a full-blown valuation. A ballpark estimate may be enough for planning purposes. We recommend that business owners obtain an annual ballpark valuation of their business as a way of keeping track of how well they are doing at building value and as a way of staying abreast of the market value of what tends to be their largest asset.
For some assets such as homes and cars there is an active secondary market and an abundance of information on comparable sales. However, with privately held businesses the situation is vastly different. Although there is an active market for these businesses, the market is not liquid. This means that transactions take a great deal of time and effort to conclude. For this reason, the valuations of privately held businesses can be more complex and sometimes more subjective than many other kinds of assets.
There are three types of business value: fair market value, investment value and liquidation value. The fair market value (FMV) of a business is the hypothetical price that a willing buyer and a willing seller with mutual knowledge of all the facts would agree to pay. For clarity, FMV is the estimated value, and market value is the actual value paid.
The investment value of a company represents its value to a specific investor, such as a successor in a family business, a competitor or another company looking to vertically integrate. The valuation is based on specific investment requirements and expectations, normally of the purchasing entity.
Lastly, liquidation value is based on the assumption that the business is worth more dead than alive. This means the company is no longer viable.
A comprehensive business valuation process involves comparing several different approaches and selecting the best method or, commonly, combining various methods based on the analyst’s knowledge and experience. The most common simple valuation methods include using industry rules of thumb, industry standards for EBIT and EBITDA calculations and comparable transaction analyses.
Once the balance sheet is adjusted and the financial statements are normalized to show recast earnings, more detailed valuation methods may be used. They include: capitalized earnings, net present value (or cash flow), discounted future earnings, excess earnings and various asset value approaches.
A base-line business valuation is essential before any exit planning decisions can be made. Given the importance, it is essential to work with professionals who have real-world experience and intuition about how the market would perceive the company and what kind of demand will be generated for it.
By obtaining accurate valuation figures, advisors can successfully help their client’s assess options available, options that can save their clients many thousands of dollars – options which will allow their clients to sell right and retire well.
Jeff Kraai is president of Exit Strategies Inc., specializing in confidential business sales and retirement transitions. He can be reached confidentially at 360-696-5812 or at firstname.lastname@example.org.