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5 Things You Need to Know About the Worth of Your Business

Vol. 26 Issue 3

Post Categories: Finance, Money

If you haven’t taken the time to find out the fair market value of your business, you could end up selling it for less than it’s worth, or your heirs could pay more than the fair share of estate taxes upon inheritance.

To safeguard against preventable mistakes, here are several things to keep in mind when it comes to maximizing your company’s worth.

 Establish Your Objectives

As you consider your exit plan, keep in mind that there are several steps you’ll need to work through, based on certain objectives you establish. For example, you’ll need to factor in the date you wish to exit, the amount of cash you’ll need from the transfer or sale of the company and your choice of a successor (or who you will sell or transfer the business to). In the course of achieving these objectives, most owners want to receive full, fair market value for their companies or ownership interest in order to reach the finish line.

Test Your Objectives

Once you establish your objectives, you’ll need to determine whether they are realistic. One of the first things you’ll need to do is evaluate how much money you will need to maintain your lifestyle into retirement. The answer to this question, along with the timeframe until you wish to exit, is critical for deciding how to proceed. If the growth rate of your business is unrealistic to achieve those objectives, you must either extend your timeline or lower your financial expectations. A business valuation specialist can help you through this process.

Know Your Basis for Tax Planning

Understand that various exit paths (sale to third party or transfer to insiders) come with different tax implications. Without appropriate planning, your tax bill can take a huge bite out of sale proceeds. Given that tax mitigation strategies often take years to implement, it’s key that you start planning well before exiting. To do this, you’ll need an accurate estimate of value.

In a transfer to key employees, for example, a common transfer technique (designed to reduce the total tax liability between the owner and buyer) is to initially transfer a minority interest at a discounted value. Using a “rule of thumb” valuation to support a minority discount simply will not work when the IRS asks you to justify the discount. You need the valuation of an independent valuation specialist who is able and willing to defend the valuation before the IRS.

Understand Your Target Buyer

It surprises many owners to learn that business value is relative and not fixed. It can vary based on your choice of successor as well as on the conditions under which the transfer is made.

If you are contemplating a sale to a third party, the business value is dependent not only on the intrinsic value, but on the “external” condition of today’s mergers and acquisitions (M&A) market for that type of business in a particular geographic area. The M&A cycle is constantly changing based on a variety of factors, such as the cost of financing, the state of the stock market and the availability of capital. The market can dictate not only the EBITDA (earnings before interest, tax, depreciation and amortization) multiple, but also the terms of a possible third-party deal.

Value also fluctuates depending on how you plan to use the valuation. In co-owned companies, unless owners periodically update value established for the buy-sell agreement, one owner may receive too much or too little (upon death, disability or departure) while the other may pay too much or too little. Outdated valuations can result in litigation and loss of business value.

 Create Incentive Plans

An important part of any exit plan is to grow business value. Part of that value is wrapped up in your key employees. So, whether you are transferring your company to an insider group or contemplating an outside sale, you must retain those key employees.

Incentive programs can both motivate and “handcuff” key employees to your company. These plans are typically based on formulas, and the most successful (whether cash or stock based) use methods linking the size of an employee’s bonus to growth in business value.

Exiting from your company is likely the largest financial transaction of your life. Start planning for it early, and be sure to consult a professional to move you toward your end goal.