The Third Ingredient to a Successful Exit - Valuation
When you are thinking of selling a business, you need to know what your company is worth before you go to market. The best way to do this is to complete an internal valuation so you go into a buy/sell negotiation prepared.
The exit plan is now beginning to take shape. The goals have been identified, including the anticipated timing of exit and the preference for either an internal transfer or an external sale to a third party. The financial needs have been quantified, including how much is required from the sale of the business to achieve the financial goals.
Now that we have determined where the business owner needs to be upon exit (i.e., the financial needs), the next step involves assessing the business owner’s current net worth, which includes the value of the business. For many business owners, this can represent a significant proportion of their total wealth.
An independent business valuation is an important benchmarking tool that can be used as a basis for enhancing the value of the business over time. It can also be used for insurance coverage purposes and for tax and estate planning purposes (two other important considerations dealt with under the comprehensive financial plan in Ingredient 2).
A current business valuation is also useful in the event of a potential shareholder or matrimonial dispute. A recent article in "The Globe & Mail" newspaper stressed the importance of obtaining and updating a business valuation every two to three years as companies grow and take on other shareholders; otherwise, there could be a battle over the valuation of the company in a shareholder dispute or divorce. Having this type of dispute drag on for years could also drag the company down with it.
To illustrate the importance of Ingredient 2 (Financial Needs) and Ingredient 3 (Business Valuation) in the exit planning process, assume a business owner requires $8 million from the sale of the business (net of taxes and other liabilities) and the business is currently worth only $4 million (net of taxes and other liabilities). This is the shortfall referred to under Ingredient 2. Once this shortfall is quantified, an action plan for enhancing the value of the business prior to exit can be developed and implemented. The value enhancement process takes time, which is one of the reasons why business owners should begin the exit planning process at least three to five years prior to an exit.
A professional business valuator can assist with developing a value enhancement action plan. An experienced valuator will be able to identify the key value drivers that the business owner should focus on to increase the company’s value up to the level identified in Ingredient 2 (Financial Needs). Usually, you would want to engage a business valuator that understands your business or is located in your geography. While the process of completing a full business valuation is technically challenging and requires a professional valuator, you can click here if you'd like to learn how to complete a simple valuation in Excel.
Once you have completed the valuation and understand what your company is worth, then you can start thinking about what exit options your business has. In my next article "The Fourth Ingredient to a Successful Exit - The Exit Options," I describe all the different channels that you can take to sell your business.