For typical business owners, the answer to one question determines their ability to leave their businesses successfully: “How much money will I get when I sell?”
This is one of the reasons why owners should know the value of their businesses.
Realistically, business owners can’t exit their businesses unless they achieve financial independence, and the primary source of that independence is likely to be the funds they receive for the business when they leave.
Case Study
Let’s look at a fictional owner, Ron Nee, the owner of Landscaping Supply Company, to see why obtaining a valuation well before the owner’s exit date is so important.
For years, Ron figured he could sell his business for more than enough money to retire comfortably. He based that belief on his understanding of his industry’s valuation rule of thumb: a percentage of gross revenue. Using that rule, Ron calculated that his company was worth about $3 million, which was more than enough to finance his post-exit life.
When Ron decided that it was time to sell and met with a transaction intermediary, he learned that the rule-of-thumb approach didn’t apply. Ron discovered that buyers would base their offers on a variety of factors, particularly, the amount of EBITDA rather than revenues (the basis for Ron’s estimate). Based on EBITDA, Ron’s business was worth $1.5 million, half of his incorrect estimate
Because Ron had relied on an incorrect assumption about the value of his business, he wasted valuable time coasting to his exit date. Had he retained a professional to estimate the value or provide a range of likely sale prices before he was ready to exit, he and his advisors could have focused on increasing the value of his business.
The Moral of the Story
Ron Nee failed in a fundamental aspect of Exit Planning: knowing the value of his business. By not getting a professional valuation or estimate of value, he never knew how far away he was from exiting. Because they lacked accurate information, neither Ron nor his advisors took any action. It is vital for business owners and their advisors to determine value now, at the outset of what may well be a 5–10-year period of planning and execution, to assure a successful exit.
Benefits of a Business Valuation to Business Owners
- It tells them—objectively—how much value they need to add to the business.
- It gives owners and Exit Planning Advisors the ability to monitor progress toward their ultimate financial objective.
- It determines whether and when owners can reach their Exit Objectives.
- It provides a basis for estimating and minimizing tax consequences particular to the Exit Path the owner chooses.
Thus, every Exit Planning Advisory Team should include a credentialed business valuator and one or more transaction intermediaries: a business broker or investment banker.