My Business is Worth WHAT!?

As a CPA I've had the following conversation too many times…

Business Owner – “I've decided it's time to retire. How much is my business worth?”

Advisor – “How much do you think it's worth?”

Business Owner – “I really don't know but, if I had to guess, I'd say around $2.5 Million.”

Advisor – “Well, uhhhh, actually, you might find that if we did a valuation of the business, it may only be worth about $500,000.”

Business Owner – “That's impossible, I can't retire on that…”

And so it goes. That's probably not what you want to hear is it? Sorry, but having done many business valuations for our business owner clients, the above is often our reality.  The good news is that it doesn't have to be you.

The fact is most business owners don't think about what their business is worth until it's too late. The vast majority of owners don't plan for the sale of their business and as a result they don't take any (and I do mean ANY ) steps to maximize their return on their years of investment.

That's a symptom associated with owners that spend too much time working IN their business and not enough time ON their business. These owners don't think in terms of selling their business at some point in time. Frequently, they view the business as a vehicle that provides them with an income and there is a rather fuzzy thought or picture involving a sale to fund their retirement.

Consider this…

For most business owners their business is the single largest asset they have.

At the time of retiring the average business owner does not have a funded pension beyond what they have set aside in their own and their spouse's IRA accounts; most will have a personal residence that has only recently had the mortgage paid off and fewer will have a significant unregistered investment portfolio. Remember, these are averages so your circumstances may be better or worse. In many situations your family business will be your most significant financial asset to provide for your retirement years.

You should be asking yourself these questions:

1. Do I really know what my business is worth? 
2. Have I had a professional business valuation prepared recently?
3. Do I know what factors drive the value of my business?
4. What things should I be doing right now that will influence the value I receive when it's time to retire or sell?
5. Should I be making some provision for the business in my retirement planning?
6. Did my investment advisor consider the value of my business when determining my portfolio asset mix (equities and fixed income securities)?  Did they classify my holding company's investment in land and buildings as equity or as real estate or did they consider it at all?

It helps if you think about the family business as an investment. The sale of a business is almost always a very emotional ordeal for owner/managers and, as we can all probably attest, emotion is not always helpful to us in reaching sound financial decisions.

Our experience has been that owners frequently think of their business “as their baby” because of the years of work (sweat and tears), nurturing and growing the business. The business, whether we want to admit it or not, has wound its way through our lives and impacts on almost everything we have done since we started it.

However, you need to keep in mind that there are some big differences between your business and publicly traded shares beyond the emotional issues. You need to know that two of the biggest differences are:

1. There may not be a ready market for your company, and
2. The market price for your business can vary significantly depending on the purchaser you are able to attract. 

Of course, you can influence both to your advantage, but only if you start planning now! It's never too early to adopt this mindset. It's no coincidence that the things that will increase the value of your business will make your business life more rewarding and enjoyable!

Your business, if properly run and prepared for sale, could (and I would suggest should ) eclipse the value of your other assets at the time of your retirement or the sale of your business.

In the meantime don't forget about Value Drivers – what are they?

As a business owner you are probably aware that there are many different factors that “drive” or impact the value of your business.  There are so many in fact that if you were to make an exhaustive list it would likely fill several pages. 

If you had such a list where would you start?  If I were in your shoes I would want to start on the ones that have the “biggest bang for the buck.”  But how do you know which ones those are?  I would like to give you a couple of clues that will start you down the right track.  Before we get to that, however, we need to talk about some of the motivations that buyers have when considering the purchase of a business.

Buyer Motivations

The following are some of the more common motivators for purchasers of businesses or professional practices:

1. Many (more than you might think) are looking to “buy a job”;
2. To take control of their own destiny.  The desire to be their own boss is a very real and very strong motivator for a considerable number of purchasers;
3. To realize an acceptable rate of return;
4. To achieve a market position or presence that they didn't previously possess;
5. To eliminate competition;
6. To achieve “economies of scale” by way of cost savings, access to capital, vertical or horizontal integration, etc.;
7. To gain access to patented technology or processes.

Specific Drivers

1.       Size

In general, the larger the business, the more it is viewed as an investment.  As an investment, return on that investment becomes a key value driver.  On the other hand, the smaller the business, the less it becomes an investment decision and the more it becomes a function of personal motivation.  This is where the “buying a job” driver becomes more prevalent.

It's important to understand that as the size of your business changes so do many of the factors that a potential purchaser considers throughout the acquisition process. 

I have witnessed numerous occasions when “small” businesses ($200,000 or less) sell at prices that are significantly different than what is economically rational based on their cash flows and earnings.

Once you reach the next level of transaction ($200,000 to $400,000) the purchasers are more sophisticated, the economic analysis becomes more rigorous, the emotional value diminishes and you have crossed into the territory where transactions begin to be evaluated based on their investment merits.

Above this level I would suggest that you are dealing with more sophisticated purchasers who will without a doubt view the transaction from the investment point of view and will bring with them higher level advisors who specialize in the valuation of businesses.

2.     Persistence of Customers, Suppliers and Employees

The more persistent and predictable your customers and suppliers are, coupled with low employee turnover, the more the business value will be evaluated based on the cash flows and earnings of the business.  Each of these is a characteristic of risk – the more you can lower the risk to the purchaser (all other things staying equal) the more the purchaser should be willing to pay you for your business.

3.       Ease of Entry

As a general statement, the easier it is to enter a particular industry, the less a purchaser will be willing to pay.  On the other hand, if there are substantial barriers to entry (such as: patents, licenses, franchise agreements or permits) the less resistance you should get to a higher price.

4.       Competition

Competition is often viewed as a “bad thing”, however, it doesn't necessarily have to be.  If you combine considerable competition in a given marketplace with the first three items mentioned above the result can be a price far greater than what might otherwise have been possible.  In these situations a purchaser may be willing to pay a premium to realize synergies or economies of scale.

The above should give you a flavor for some of the value drivers in your business, but I haven't even touched on the biggest factor of all for small businesses: goodwill and the various types that exist. That will have to be a topic for a future edition of  “Ask the CPA”.

In the meantime Dierking, Lockie & Associates, PC can be instrumental in ensuring that your business practices are maximizing your business value.  Specifically, we can assist you in creating systems that can have a significant impact on item #1 and #2 noted above.

Remember: “The wise businessperson begins planning the sale of their business the first day it opens for business.”

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