The Role of Business Valuation in Succession Planning
Many small business owners spend a lifetime building their business. But many fail to plan the transition of their business. This transition process is known as succession planning. It can be difficult for an owner to decide whether to sell, dissolve, or transfer the business to a family member, employee, or another interested party.
There are many complicated issues to consider when creating a succession plan. A few include dividing business interests, determining the value of the business, and planning for taxes. As you put together your succession plan, include not only your financial and legal advisors but also a qualified valuation expert. Doing so will increase the chances of your business’s continued success after your departure.
Understand the Value of your Company
As you begin to map out the transition of ownership from one generation to the next, the first step is understanding the value of your small business.
Many family business owners have a fair sense of the value of their business. However, because of emotional ties they may not be as objective as they should be. Using a business valuation professional will help to ensure a fair and objective value. Additionally, obtaining a business valuation from an independent and qualified appraiser can protect yourself legally and help to ensure compliance with tax regulations.
Factors Influencing the Value
The next step in succession planning is understanding the factors that impact the value of your family business. Without a professional valuation, many market conditions and other key factors may not be considered. A valuation expert can help the owner truly understand the value they have created in their business. They can also help them view the business through the eyes of a prospective buyer and what they would be willing to pay.
Often the state of the economy impacts the value of a company. A valuation analyst weighs the economic risks to more accurately reflect the value. Keep in mind firms that operate in stable or rapidly growing industries are more valuable. Industries such as healthcare, energy, and education have favorable growth prospects as there is a consistent demand for these products/services.
The owner of a family or closely-held small business often has unique skills and customer relationships. This is known as “personal goodwill” and may result in a discount to the value. This is because the transferability of these skills and relationships may be lost once the owner exits.
Business value is not just tangible assets such as land, equipment, and cash flows, but rather a mixture of tangible and intangible assets. Intellectual property falls under goodwill and can include copyrights, patents, brand recognition, customer/supplier relationships, websites, trade secrets, among others. Goodwill often accounts for the largest part of the value of your company.
Potential for growth and earnings:
Despite the industry your company operates in, the business value largely depends on the company’s growth and earnings potential. This factor is often one of the largest that influences a company’s valuation multiple.
Businesses with higher risk are typically valued at a lower valuation multiple. Whereas lower risk equates in higher multiples which translates into higher values.
Projected cash flows:
Stable, above-average earnings increase the value of your company. A company with stable and growing cash flow is more valuable. Both the market and income valuation approaches consider future earnings when determining the value.
Using an outside valuation professional can bring a unique and objective perspective on the value of your family business. They will consider many factors you may not have realized have value. If a business owner procrastinates or chooses not to succession plan, there is often a significant loss of wealth and hardship when the time arrives to transition the business. Not to mention you may lack a suitable successor or have your heirs disagree about shares of ownership.
Peak Business Valuation is here to help. By understanding the value of your business, you can be more effective and accurate when succession planning. We are always happy to answer any questions you have! Please reach out via email or through a phone call.Schedule Your Free Consultation Today!