All business owners will exit their businesses someday, whether by choice, death, health, or other circumstances, and planning for the inevitable is crucial. Owners need to answer the question, “What will happen to me, my business, and my family when I leave the company?” Proper planning through a business valuation ensures owners meet their financial needs and also ensures their businesses can continue as they desire. In other words, by knowing what your company is worth today, you’re taking the first step toward planning for tomorrow.
Focusing on growing and protecting the business value of your company gives you the best chance to leave the business when you want, for the money you need, and to the person you choose, yet it all requires planning. Through proper planning you can maximize the company’s value and minimize risks, allowing you to meet your financial goals.
Gaining Insight to Drive Value
Say you determine that now is the time to do some planning, and you have a business valuation of your company prepared by a qualified appraiser. Perhaps you want to sell your business in the next five years, or maybe longer. What if the value isn’t enough to allow you to exit your business in the time frame and with the financial security you dreamed of? This is one of the most important reasons for having a business valuation done first. It provides you the opportunity to determine ways to increase your company value today and make changes now.
Value drivers are specific business characteristics that drive growth and can be uncovered as part of the valuation process. While each business is unique, there are six areas of your business that, with focus and a little time, can have the greatest impact on your company’s value. They are listed here in the order of how likely they are to affect your business’s value. The sooner you identify the current state of these six drivers through a valuation, the more time you’ll have to make improvements as needed.
- Next-generation management. Having a management team with the ability to replace you is one of the most important drivers of your company’s value. The good news? With proper planning, you can create a strong team and positively affect your business’s value.
- Operating systems demonstrated to increase cash flow sustainability.
- Demonstrated scalability.
- Diversified customer base.
- Proven growth strategy.
- Recurring revenue that is sustainable and resistant to commoditization.
Now that you know what drivers are important, consider the following:
- Ensure you have a competent management team who can run things without you. The management team should be able to overlap duties and step in and cover duties should a team member leave. In other words, don’t rely on the abilities of any one individual.
- There will be changes in cash flows as revenues and expenses fluctuate, but it is important to have operating systems in place to be able to review the fluctuations and figure out how to increase cash flows over time.
- What if the demand for your service or product increases? Do you have capacity to meet increased demand? Make changes to meet an increase in demand and be able to grow as demand grows. Consider building capacity, machine capacity, employee capacity, and system capacity, to name a few.
- Build your business by focusing on a wide variety of customers when possible. If a large percentage of your business comes from one customer, there is a large risk if that customer chooses another supplier. If you rely heavily on one customer, consider a contract that would lock you in for a period of time.
- Find ways to increase your sales and reduce expenses over time. You want to demonstrate the ability to grow consistently over time.
- Find ways to have recurring revenue that will remain consistent in the future. Review your current policies and determine whether there are ways to change your current revenue structure. Determine what is unique about your service or product and explore how to best sell it.
Growing business value and cash flows can help you close the gap between what your business is currently worth and what it must be worth to satisfy your financial goals. Growing business value and cash flows is vital to your ability to exit when you want and for the money you need.
By identifying and improving the value drivers, you are more likely to view your business through the eyes of a potential buyer or internal successor owner. You can make decisions based on the benefit to the company and not to you personally.
Valuation Report Options
Valuations come in different shapes, sizes, and degrees of formality. In fact, under AICPA standards, SSVS1, there are three types of valuation reports—a detailed report, a summary report, or a calculation report. Under certain circumstances, such as for tax purposes, a detailed report is required. Otherwise, the determination of whether to prepare a detailed report or a summary report is based on the level of reporting detail agreed to by the valuation analyst and the client. The analysis for a detailed report or summary report is the same; the only difference is the level of detail in the write-up.
The third report option is a calculation report, which can be used to meet a company’s needs when a detailed or summary report isn’t required. In a calculation, the client and analyst agree on the valuation approaches and methods to be used and the extent of procedures the valuation analyst will perform. The analyst expresses the results of these procedures in a calculated value. A calculation engagement does not include all the procedures required for a valuation engagement. Under the right circumstances, a calculation can be a tool that can be performed at a lower cost and still allow information needed for planning purposes. Ultimately, the purpose of the report will drive the type of report needed.
There’s Immediate Value in a Business Valuation
Once you determine your financial goal for the company’s value, you can figure out how much and how quickly growth needs to occur. By identifying value drivers in your business, you can concentrate your efforts on areas that need the greatest improvement. And it all starts with a business valuation. Why not have one performed today? Your future self will thank you.