For many business owners, the single largest asset in their investment portfolio is the business they own. Unfortunately, when they receive investment account statements from their financial advisors, the value of the business asset is typically missing. Ironically, this asset is normally the largest source (through wages & distributions) used to buy all the other investments in their portfolio. Without the value of the business, you really do not know the total value of your nest egg.
Rule of Thumb or Price Multiple?
According to a recent survey by UBS, 40% of business owners plan to leave their business in the next five years, yet half do not have an exit plan. Your business value is too important to rely on an industry rule of thumb, or a price multiple that you heard at the last trade conference.
Just like people, no two businesses are alike. With an independent business valuation by a qualified appraiser, you can decide whether your nest egg is big enough, or whether you need to take steps to increase the value of your business before exiting.
Business value is heavily influenced by business risk, cash flow and growth potential. The business appraisal not only gives a value estimate, but often reveals areas of risk as well as a cash flow measurement and areas of growth potential.
As the owner, you are the ultimate business insider, and probably the most qualified to make changes to reduce business risk or improve cash flow. So, plan early, while you still have the enthusiasm to make changes to your business. Not only can this increase business value, but it may also increase distributions while you continue to run the business. Of course, the increased distributions can be used to make other investments in diversifying your portfolio of assets.
Selling to a Third Party
A family business survey by PWC indicates that only about half of family businesses that plan to change hands in the next five years will be kept in the family. When selling to a third-party, do not rely upon last-minute window dressing to make much of a difference on the selling price for your business. And, do not wait until you sell your business to think of all the great ways the business could be improved. Giving this pep talk to any sophisticated buyer will fall on deaf ears. Prospective buyers will be thinking (perhaps asking), why hasn’t the owner already taken steps to make these fabulous changes? Instead of planning your excuse, plan early enough to make the changes.
Buyers are not interested in paying top dollar for businesses that need to be fixed, and they will probably discount the offer price for the risk of implementing the required changes and the uncertainty of success. To minimize this implementation risk, the buyer may negotiate for a large part of the purchase price to be contingent upon achieving certain financial performance benchmarks in the future, such as certain revenue or profit levels. This means that the critical cash level that you needed from the sale, perhaps to retire with a certain lifestyle, could be in jeopardy. You are now waiting, hoping and relying on the buyer to achieve the expectations that you claim could have been achieved if these solutions were already implemented.
Whether your business model needs major fixing, or simply some minor tweaking, aren’t you more qualified to make the necessary business changes now? Take steps in time to show improvements in historical financial performance over consecutive years. Not only are the future cash flows preserved, but the implementation risk is not assumed by the buyer, which means both levers (cash flow and price multiple) may increase, resulting in a much higher sales price.
The keys to business exit planning are a qualified team of advisors willing to work together with the owner in establishing a defined exit plan, and an independent business valuation prepared early enough to make changes to the business if needed.