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The importance of an up-to-date valuation on your enterprise
How can you navigate forward to a fruitful exit or transition plan without knowing the true value of your business?
By Rick McDonald
To the majority of baby boomers business owners the value of their enterprise represents 70-80% of their net worth. Let me ask; from where is that number coming? In far too many cases; it is what a friend or a buddy at your golf course told you; or maybe what you heard a competitor went for. So called industry “Rules of Thumb” can be both vague and dangerous.
Every business is different, with its own strengths and weaknesses. How deep is the bench? How much recurring revenue does the business generate? These things have a huge impact on the value of your business. You need a professionally prepared valuation to know just what you have and what you can count on going forward.
Here is the problem: 80 % of you have a financial gap. This gap is the spread between what you have (the value of your business, saving and retirement) and what that will yield as compared to what cash flow you will require in your post exit life. This gap needs to be addressed immediately!
Value is driven by EBITDA (earnings before interest, taxes, depreciation and amortisation) and a cap rate of multiple. This value needs to be defensible in the potential buyer’s eyes which focus on the cash flow of your entity.
So what do you need to do? Here are a few things;
1: clean up your day to day operations and scrub down the income statement;
2: revisit your SOP’s
3: increase your recurring revenue stream and strengthen the relationship with key employees.
Always ask yourself, would I buy this business?
Understand how digital accelerators, lead magnets, funnels and digital marketing impact your industry. Be sure the SIC on your business tax return is accurate. The wrong code can negatively impact your cap rate.
Cost out your product or service as if you were just starting out. You need to see if you are still making what you thought you were making. For many companies this shrinking gross profit margin has been exacerbated by Supply Chain and Labor shortages
What is happening in your industry? How is it changing? Are you positioned to handle this change? Understand that your company needs to be profitable (sounds obvious), sustainable and transferable to even consider an external sale.
Do you have depth in your management team? Do you have a strong bench that is ready to slide in and step up? What is your customer or client concentration and how dependent is your business on you? These issues are really very important.
All these items have an impact on either your EBITA or cap rate. But let's not forget to talk about your record keeping. Be sure your accounting records are accurate and reflect the results of your operations. Scrub them of expenses; personal in nature; that find their way on most closely held company’s books A potential buyer’s view of value can get tainted very easily. Far too many small businesses are using internally generated financial statements from popular software packages that maintain their general leaders. Any external buyer will insist on professionally prepared, reviewed; or at the least compiled financials by an outside CPA.
Value drivers impact cap rates (multiples). Cap rates have been at all time lows which means the multiple have been at all time highs. Increasing sales have never been more important, but can your management team scale it up. If not, you may need the capital to build a more robust management team. Some companies are turning to private equity to fund this.
There has been a shift where these PEGS are now looking at smaller and lower middle market businesses and under the right circumstance, will go 2-10 times EBITA to acquire as little as 10% to as much as 90% of your company. These companies are fine tuned and “buffed up” to sell after a 3-5 year period giving the owner a “second bite of the apple”.
From here, I want to make a comment on value building strategies to build the value and help close your financial GAP. We recognize the importance of keeping relationships which need to be honored and respected as to their role with both your managers and clients/customers. These “A list” relationships drive value, and must be able to be transferred to a potential new owner.
Our interview and your interaction with us will help identify where you may have problems. We have the answers and the design of our value proposition delivered; not only a subjective answer, but one that is objective in your circumstances.
We understand the need to bridge your financial gap. We design the program to give you the clarity as you work on your business; not just in it. Based on your strengths and weaknesses, we will help you design the plan which allows you to successfully exit or transition the ownership of your business on your terms. If you wish, we can participate in the implementation of the plan. But again, it all starts with getting a rock solid and defensible valuation of your enterprise.
Many times creating these plans uncovers issues that are uncomfortable for the owner to address. Well, even better, as you end up with many best practices that will change or even create new procedures to address what may have gotten away from you over time.
Values are different, depending on who your buyer is. A sale to an outside (external) buyer where that is synergy, or to a strategic entity, will give rise to the highest value. Internal transactions to your management team or family members will yield an investment value which is smaller. However, internal sales can be a controlled exit over a number of years which provides flexibility in both structure and tax impact.
Along with working on increasing the value of your enterprise you should focus on increasing savings outside the business. Closing the GAP is a two pronged initiative. Get the kids off the family payroll. Let’s face it, they need to pay their own way. On the personal implementation of a cash balance retirement plan; yes, you will have to include your employees, but you need them to assure a smooth transition. So the added expense to the company will be worth it in the end. This is a discretionary expense and is added back to your EBITDA which means it will not reduce the value. Remember when you sent your kids to college, there was financial aid. Well there is no financial aid for retirement. By taking the steps to increase the value of your business along with increasing saving and the level of retirement plan funding; you can attack your financial gap and have a shot of pulling this off.
Chances are; you are looking at the perfect storm. You are tired and want to retire. Time is not our friend! The value of your business may not be what you think it is. To make matters worse you have given your financial planner and inflated business value; in many cases twice what it is actually worth and that is what your retirement plan has been based upon. What you now have in retirement and savings is woefully shy of where it needs to be. This collective yield will not be enough to fund your lifestyle. Yes, it is a math problem!
I leave you with one last thought, well actually two: If you feel like you have been punched in the nose; good, as that was my intention. You cannot deal with a problem if you don't know one exists. Second, do any of us want to sit with our spouse during a planning session with our wealth manager; look he or she in the eye and say “we are going to have to scale back our lifestyle when we retire.” No one wants that long silent ride home with the person who has always; through you, had things under control.
Take control, get some clarity and get an analysis of the value of your enterprise by taking our Exit valuation Survey below.
There should be enough time to design a plan of action to allow you to retire on your terms and with the life you want, and it all starts by taking this survey which takes just a few minutes of your time.
How It Works
It's time to face the truth. If you don't plan your exit correctly, you could end up working until you die. Your journey to a successful sale and increasing the value of your business by 30-50% starts with taking our Exit Valuation Survey. This tells us exactly where you are now, the exact performance of your business, and what you need to do to improve. You can access your buyer Risk Report and speak to our analyst team on a complimentary call to discuss your results, increasing value and exit options.
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*The Lower Middle Market is comprised of businesses worth $5-$30 million, typically having EBITDA of $1 million - $4 million.
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