Valuation enhances your business plan when it comes to the company’s general well-being and how it fits into your exit planning strategy. It gives you the vision and direction to enhance the value of your company, so you can achieve your business transition objectives.
By prioritizing valuation, you understand the market value of your company. That information helps you make better business decisions, resulting in a more valuable asset when it comes time to sell.
What Is a Business Valuation?
Business valuation is a complex process most often performed by experienced professionals to determine how much your company is worth and if it’s enough to support your retirement plans.
This process involves an in-depth analysis of financial documents and includes the identification of company-specific and industry-specific risks, destroyers and enhancers of value, industry trends, market conditions, competition, customer concentration, and other factors impacting your company value.
Why Should You Prioritize a Valuation?
Getting a business valuation is critical for businesses at any stage, but it’s best to be proactive, rather than reactive. It helps you prepare for many other transaction-triggering events such as:
- Exit/retirement of a partner/shareholder
- Estate planning
- Strategic planning
- Litigation and taxes
- Funding, etc.
Exit/Retirement of a Partner/Shareholder
Transaction-triggering events affect your business plans and the company’s future, so a business valuation is like insurance in that it’s better to be prepared than caught by surprise. Many company owners only sell their companies or exit their businesses once in their lifetimes; therefore, they must ensure they get it right. There are no do-overs. The results of an initial business valuation help you identify the best exit options available to you.
For many business owners, the sale of their business is their retirement plan. But you can’t plan your retirement income if you don’t know the value of your business or if you have any outdated buy-sell agreements in place or any other housekeeping item that could lower the sale price of your business and thus your retirement income. It’s critical to proactively plan your exit after you get a business valuation to ensure a comfortable retirement.
Should valuation reveal a lower-than-expected value for your company, a valuation advisor can help you identify operational efficiencies, create strong cash flows, and devise other measures to enhance business value.
A business valuation also is helpful for estate planning. For example, parents may plan to place the business in the oldest child’s hands and set up a trust for the remaining children, securing equitable distribution of the bequests. Now assume that, before transferring the business, a recession hits the company hard and the oldest child’s inheritance dwindles in value. Business valuation can help the parents make appropriate estate planning changes to ensure that, when the final allotment of gifts happens, the oldest child receives as much share value as the other children.
Suppose you want to give the right financial incentives to your company’s key people who contribute to its success. However, sales, profits, or other annual measurements neither reflect the actual growth of your company nor encourage your key people to engage in long-range thinking. A business valuation will help determine the baseline value (the starting point) which can be used in deferred compensation arrangements (e.g. stock appreciation rights, etc.) and to measure business growth.
Litigation and Taxes
Getting a business valuation may save you from costly litigation and tax penalties resulting from using the incorrect value to settle transactions concerning ownership transitions. If you underestimate your company’s value, you might miss out on tax-saving opportunities. On the other hand, by overestimating your business value, you could invest unnecessary time and funds planning for the value you expect to receive but will never materialize.
Suppose you want to raise funds. Even if you don’t think you need a business valuation, other parties do. Banks, private equity firms, potential investors, etc., will require a valuation performed on your company before investing in the business, but the results of their valuations may not be in your favor. Therefore, you’ll want to defend or demonstrate a higher business value. A business valuation that you order may enable you to rebut the other party’s lower valuation of your company.
How Often Should I Get a Business Valuation?
It depends! A business valuation is usually valid for up to a year if underlying conditions remain constant. However, if you want to use the old valuation for a different purpose, then we recommend you have a new valuation performed. Substantial changes in the business, industry, and economy merit a new business valuation.
If you want to sell your business, then get an initial business valuation five to seven years before you put the company on the market. The valuation will establish the company’s baseline value from which to start your exit planning journey to sell the company for the amount that satisfies your goals.
During the exit planning process, get annual business valuations to track the success of your value creation initiatives and point out where to make changes to your exit plan.
Routine annual valuations will guide you to make better business decisions, even if you do not foresee a transaction-triggering event in the near future; it’s just good business sense.
Be Smart, Don’t Postpone Valuation of Your Business
Getting a business valuation is an essential aspect of transaction-triggering events like succession, estate planning, exit planning, selling a business, etc. You will eventually leave your business; when this happens then depends on many factors informed by the current value of the business.
But be cautious—do not attempt to conduct a business valuation on your own or with unverified “free” sources you may find online. For the best, most accurate results, engage qualified business valuation advisors who will direct you through the most suitable valuation approach for your unique business. Also, should the IRS challenge your valuation, you’ll need Certified Valuation Analysts to determine the value of your company.