Ever wonder “what is my business worth?” or “who will buy my business when I am ready to retire?” It is never too early to start thinking about your business value, and your exit strategy. If you plan ahead and ensure your business runs well without you, and you will be able to pass it on and make money as you sell it.
Even as you are working to grow and manage your business, it is important to keep in mind:
- Will the sale of your business be sufficient to finance your retirement?
- What are the key variables that impact value and how can you impact them to increase the overall value when you do, eventually, exit?
In order to answer these questions, you need to understand how a business is valued. Business value is determined by two key factors: The cash flow and the multiple.
Cash Flow
The cash flow of the business is determined by the profit, plus or minus a number of “normalizing adjustments.” Typical adjustments include owner’s compensation, depreciation, and any other expenses that have a highly variable or somewhat discretionary component.
The Multiple
The multiple is even more important. It goes without saying that as your bottom line grows, the value of your business also increases. Therefore, it is critically important to focus on sales and profits. However, there are many other key value drivers that influence the multiple. A business with profits in the one-million-dollar range can have vastly different values depending on a number of factors, including:
Successor: Qualifying and choosing a successor by redefining roles & responsibilities, training, monitoring, and dispute resolution. For outside purchaser: determine optimal outside buyers and their motivations. Consider your marketing strategy as you approach them.
Management/Operations: Do you delegate? Do you have good “bench strength”? Can you take a two-month personal holiday? If you did, would your business still exist when you got back? If the answers are no, it will be hard to sell or transition your business at all, resulting in a lower multiple.
Financial: Ensure your bottom line is healthy and not clouded by personal expenses. Your business is valued based on a multiple of sustainable income. You need to prove your business makes a good profit, and that it is sustainable without you.
Taxes: We all hate them, but did you know paying a dollar in tax could earn you $24? Here’s how: If you are paying for personal expenses through your business, you save perhaps 12% tax (small business rate). When you sell, you sell for a multiple of your bottom line. Paying for eight dollars in personal expenses saves you one dollar in tax, but could cost you $24 when you sell (assume a conservative 3x multiple). Strange but true.
Legal: Review the legal structure of the company and its ownership. Try to ensure the corporation is “clean” and ready to sell, and structured to maximize the ability to sell shares and utilize your personal capital gains exemption.
Plan Ahead
As you plan for your business’ future, it is important to use big-picture thinking and understand the full range of succession planning issues. This means focusing equally on both the business and the transaction. While transaction issues are important, the longer-term business issues are where you will really make a difference in the ultimate success of the transition.
Examine all the management and financial aspects of your business. Any necessary adjustments will take time to put in place, and certain tax savings strategies can take even longer are. If you plan to sell, you can save significant taxes by planning at least two fiscal years in advance. Under certain conditions, you can even take advantage of your lifetime capital gains tax limit. Consult your tax accountant or business consultant for further information.
Steven Beal, MBA, CPA, CGA, CFA, CBV, CBI is a Chartered Business Valuator, and can provide the assurance you need when you need a formal business valuation or are thinking of exiting/selling your business.