An accuratebusiness valuation is one of the moreimportant elementsof planning for a successful future. But the journey todeterminethe true value of your business is full of dead ends and pitfalls.
In thisnewsletter, we will examine four elements of business valuation:
Valuation basics
Common valuation mistakes that you should avoid
How cash flowimpactsyour business’s value
How business value influences your future
Valuation Basics
Business valuations are a compilation of business performance, the context in which your business exists, and what a potential buyer would be willing to pay for your company.
There arenumerouselements that affect your company’s value. We call these elements Value Drivers. Some of the most important and common Value Drivers that help increase a business’s value include the following:
Installation of a next-level management team
Operating systems that have proven to increase cash flow sustainability
A solid and diversified customer base
Competitive advantages
Simply put, the more Value Drivers your company has, the better positioned it could be to have a higher business value.
Installing Value Drivers in your company is often a long-term commitment. For example, it could take you years to install a next-level management team that could run the business if you were unable to run it.This is why it’s prudent to begin installing Value Drivers long before you begin thinking about exiting your business.
Fortunately, your Advisor Team can help you identify Value Drivers that your company needs, work with you to install those Value Drivers, and help you work toward a business valuation that allows you to eventually exit your business on your terms.
Common Valuation Mistakes to Avoid
There arenumerousvaluation errors that business owners can make when obtaining a business valuation.Let’slook at two of the most common and potentially damaging mistakes to avoid.
Using Rules of Thumb
Rules of thumb are things like back-of-the-napkin calculations of business value or comparing your company to other companies without the full context that those companies exist in.
For instance, your business may have a competitor ofa similar sizethat offerssimilar productsor services. Say that competitor ends up selling for $10 million. It can be easy to assume that your business would also be worth $10 million because your business and your competitor’s business are similar. This common pitfall can set you on a course that does not allow you to eventually exit your business on your terms. In a sense,it’sliketrying to drive from New York to Sacramento, taking a wrong turn in the first 10 miles, and ending up in Saskatchewan.
Being Overly Optimistic
Another common valuation mistake that business owners make is having an overly optimistic view of their company’s value. This can be a difficult challenge for business owners to overcome.
Business owners tend to be protective and proud of the businesses that they build. While this is certainly a motivating factor that allows you to work toward more success, it can also position you to think that your business is worth more than its objective value.
The success or failure of a business that you found is a profoundly emotional experience. This can cause business owners to view the value of their business irrationally: in other words, “I built this, it is valuable to me, and I will accept nothing less than a certain amount.”
Thoughit’sa good starting point to have an idea for how much you think your business should be worth, it is also important to ensure that your business includes Value Drivers to back up your belief in the value of your business.
An Advisor Team could help you overcome these common hurdles early in the planning process. Your advisors can take a more objective view of your business, its strengths, its weaknesses, and what you need to do to build its value in ways that allow you to eventually exit on your terms.
Overcoming Valuation Mistakes
An important way that your Advisor Team can help youobtainan accuratevaluation is by setting expectations for what a business like yours could be worth.
For example, you may have built your business over the last 25 years.It’sthe driver of your lifestyle, your nest egg, and somethingyou’reextremely proud of.Based on all of your experiences in the business, you may believe that your business could be worth $50 million, when in reality, the market wouldn’t value it at any more than $10 million.An objective analysis of your company via your Advisor Team can help you be realistic about your company’s value and still be ambitious about what you think you can get for it whenyou’reready to sell it.
The Role of Cash Flow
There are severaldifferent typesof valuations that you can obtain for your business. The type of valuation you need will depend on your specific situation. However, a common thread throughout all thedifferent kindsof valuations is cash flow.
Cash flow is a commonly used baseline measurement of the liquidity of your company.Generally speaking, well-heeled buyers prefer to buy businesses that have good cash flow because it shows that your company is operating within its means and has a path toward future growth.
However, different industries, along with where the business is in its life cycle, can sometimesprovidea warped view of what the business’s financial strength really is. For example, if you were running a startup in a high-growth industry, such as technology, your company may experience negative cash flow at the beginning of its life cycle. Thisdoesn’tnecessarily meanit’sa bad business or abusinessnot worth buying. Nonetheless, for many industries, cash flow is a key indicator of the company’s solubility and thus its financial health.
Your Advisor Team could help youdeterminewhat your company’s true cash flow is and recommend improvements where necessary.
How Value Affects Your Future
For many business owners, the business is the most important financial asset they have. Even business owners who never plan to leave their businesses still rely on the implications of theirbusiness’svalue. In other words, even if you plan to die at your desk, the business’s value will still affect other people who rely on your business, such as your family, your employees, and even your community.
As such,an accuratebusiness valuation can have huge effects on your future.
One of the most striking ways that business value can affect your future isencompassed inthe idea of tainting the marketplace, which is when a business goes on the market for sale, does not sell, and then comes back off the market.
It’snot uncommonfor business owners to decide, on their own, that they want to exit their business in an arbitrary number of years that will not allow them to build business value to the point where they can exit on their terms. So, they take their business onto the market, realize that there are no buyers willing topaywhat they believe the business is worth, and then take that business off the market.
This act can have negative consequences when the business is truly ready for sale. It often leads potential buyers to infer that there is something so seriously wrong with the business that it had to be taken off the market in the first place. This can cause potential buyers to be unwilling to pay the amount you need to exit your business on your terms, under any circumstances.
Thankfully,an accuratebusiness valuation can help you avoid this common misstep, begin installing Value Drivers to help you fulfill your exit timeline, and take your business to market only when it is truly ready.
Knowing what your business is worth objectively is a powerful tool indetermininghow your business must improve or change to allow you to reach your retirement goals.
We strive to help business ownersidentifyand prioritize theirobjectiveswith respect to their businesses, their employees, and their families. If you have questions on this topic, we can help with more information or a referral to another experienced professional.
WestPac Wealth Partners is an Agency of The Guardian Life Insurance Company of America® (Guardian), New York, NY. Securities products and advisory services offered through Park Avenue Securities, LLC (PAS), member FINRA, SIPC. OSJ: 5280 Carroll Canyon Rd., #300 San Diego, CA 92121 619.684.6400. PAS is a wholly owned subsidiary of Guardian. This firm is not an affiliate or subsidiary of PAS. Insurance products offered through WestPac Wealth Partners and Insurance Services, LLC a DBA of WestPac Wealth Partners, LLC. | CA Insurance License #0I29680 | 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. | 9038706.1 Exp. 07/28