Sometimes, for business owners, it can be easier to keep your head down and avoid addressing the strategies around protecting, growing, and exiting your business.
But that’s not the best approach for you or your business.
Here at Consolidated Planning, we’ve learned first-hand what works and what doesn’t work when it comes to helping business owners address their financial concerns. We offer a process that provides the framework to uncover opportunities, maximize results and put you on a solid path to achieving all that is important to you.
In this article, we’ll delve into what exactly a business valuation is and why it matters, three crucial steps in your path towards your ultimate exit, and actionable steps you can take to get started achieving those goals sooner.
First, What Is A Business Valuation And Why Does It Matter?
A business valuation is similar to your home appraisal. It’s very murky as to what your business is really worth. You may have a sense, or at least an opinion, but you don’t really know until you sell it and someone agrees to a price.
From a planning standpoint, completing a business valuation is essential to its sale. Unlike the process of selling your home, you’re going to make really important business decisions that are contingent on the expectation of a certain dollar amount.
Options To Calculate The Expected Dollar Amount
- Certified Appraisal: This is the story of your business, assessing your accounting, your books, and your people. It’s an unbiased opinion, but is not used for legal matters.
- Calculation of Value: This will be a much higher level of analysis, including things like your intellectual property. A calculation of value is often needed for substantial legal matters like tax matters (especially for gifting), divorce settlements, or legal disagreements. This is more exhaustive, and typically would cost more than the certified appraisal of the same company.
- Software-Based Value: This estimates your value based on comparisons of businesses sold, taking into account your type of business. You’d be surprised how accurate this type of valuation could be, and it’s often easy and typically free.
In the past, business owners had Certified Appraisals or Calculations of Value to choose from, and therefore rarely took the time to value their business. As a business owner you might have gone decades without knowing the probable value of your business. Technology advances changed all of that, and like Zillow makes home values easier, software-based business valuation tools like BizEquity make business valuations fast and reliable.
We recommend having your business valued each year as a habit. It’s probably your most important asset as a business owner, so why not? But once you know the value, the next three steps are vital.
3 Important Steps For Your Business
Now, let’s say your valuation comes back and it’s what you anticipated or more. That’s great news! Now comes the leg work. There are three steps you need to take to best protect, grow, and ultimately exit your business:
#1 Protect Your Business
If your business is indeed your largest asset and your biggest source of cash flow, like we think it is, how well is it currently protected (or not) to protect that business valuation if something goes wrong. Whether something happens to you, a key employee, or if business just doesn’t go well for a year or two.
How can you best insulate your business from losing its value for unexpected scenarios?
- Disability insurance: Protect your earned income from the business.
- Life insurance: You insure your car and home for their full value, so why not the business? Insuring the value of your business at death with life insurance is always preferable to expecting partners or employees to buy you out.
- Disability Buyout insurance: Business owners might pass away, but could be disabled along the way as well. Just like life insurance protects the value of the business at death, disability buyout insurance protects the value of the business at disability.
- Overhead expense insurance: Believe it or not, insurance companies can provide funds to pay for overhead needs if an owner or key employee becomes disabled.
- An operating agreement: This is is also known as a Buy/Sell Agreement, and it should do three things: decide how to value your business should the need arise, decide what happens to the stock of the business at an owner’s death or disability, and perhaps back up the stock transfer with life or disability buy-out insurance.
- A continuity plan: This is in place for extreme events.
- Reserve funds: For unforeseen tough times.
- Retention Plan to Retain Key Employees: While everyone is replaceable, losing a key employee is painful. Losing a key employee around a key event like the sale of a business, or a change in an owner’s health is usually damaging to the value of the business. Retention plans and ‘stay bonuses’ can minimize this risk and protect the business.
You can dramatically eliminate your most current business valuation with right insurances and right documents.
Of course, let’s preserve enough liquidity on your business balance sheet somewhere so you have a cushion to withstand something going wrong indefinitely or until insurance kicks in.
#2 Grow Your Business
Even with a positive business valuation, it’s always a good idea to grow your business up until your exit. Not that your business value isn’t enough, but is it enough money for you to retire the way you want to?
Growth of your business can look very different based on who you ask. Some people may say growth is getting a loan from a bank and reinvesting in your business by opening a new warehouse, for example. But, has your business value really changed if you’re borrowing money or do you just have more leverage?
However, organic and attainable growth is all about people. Employees. It’s hiring the next employee who will be a productive member of the team. Your people do wonders for your business growth by:
- Creating new business opportunities,
- Controlling costs and cash flow, and
- Increasing cash flow and profit
This is a reliable and consistent way to grow your business because your business is valued on its profit and cash flow. Therefore, increasing your profit and cash flow, increases your value.
Growing your business doesn’t mean you have to take on massive amounts of debt to win. With that being said, this is why it’s ideal to work on growing your business and its value organically over time – making a little bit more money this year than last year.
#3 Exit Your Business
All roads lead to exiting your business on your terms. But, what is your strategy to exit your business so the full value of your life’s work can come to fruition?
We find that the further in advance that a business owner plans for the transition of the business, the more fruitful that transition is — the buyer you want, when you want it, and for the amount you want takes time. It’s probably the most complicated transaction of your lifetime, so plan ahead!
Starting only a year out doesn’t give much time to sell a business on your terms, especially when thinking of the same business with a 10 year time horizon for a planned sale. Keeping your business value in front of you every year for 10 years, helps you understand what lowers and raises your value, allowing 10 times the chances to maximize your exit terms. And you’ll be more focused.
Is 10 years the magic number? Probably not, but the right number is somewhere along the lines of the more time, the better.
Ultimately, the valuation of your business has to translate into a value that’s right for you to exit on your own terms.
3 Options For Business Owners To Exit
#1 Sell to insiders
These are people you already know, including your children in the business, key employees, or an ESOP.
#2 Sell to a third party
This is usually to a strategic buyer or a competitor.
#3 Keep until death
When the other two options are not planned for, this is the default.
Each option brings certain benefits and challenges that need to be managed. And, although you should plan for your first choice, it’s important to be prepared to contend with all three.
The proceeds from the sale, whichever path that is, has to be turned back into cash flow to fund your post-sale income requirements. Think for a moment about how much you know about your business; the risks of the business, the ways to make money, etc. Chances are, you are one of the best in the world at the job of owning and operating your business and producing profit from your business.
Once you sell your business, a new challenge emerges. You need cash flow from your business sale proceeds and for that you need investments. Investments is an area that most business owners are not well versed in, especially compared to the experience in their running the business. And that’s okay.
Your focus rightly turns from running a business, to requiring income from investments, and here is a quick example to think about.
If you had a business that sold for 10M, and you got a check for 7M after taxes, would it be enough for your retirement income needs? While 7M is a lot of money, and it is, at 4-5% of safe earnings you might only have 280k to 350k of investment income each year. In this example, does that sufficiently replace the income from the business before the sale?*
While the above is just an example, it’s an important one. As you think about the income you receive off the business currently VERSUS the income you’d receive from your sale proceeds, would the investment income from your sale be enough?
Address What Your Business Needs For Protection, Growth, And Your Exit
Whatever vision you have for your business and financial future, completing a business valuation is the first step in planning for that future.
Knowing what your business is worth is a powerful tool and better positions you in your business. Moreover, knowing HOW that value translates after your exit can help you better plan for the largest transaction of your life.
To better understand how to protect, grow, and exit your business the right way, talk with an experienced professional at Consolidated Planning about maximizing your business’ value.
2024-168086 Exp. 1/2026
Guardian, its subsidiaries, agents and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation. The information provided is based on our general understanding of the subject matter discussed and is for informational purposes only.
This material contains the current opinions of Neal Brincefield and Consolidated Planning only. These are not the opinions of Park Avenue Securities, Guardian, or its subsidiaries.
