Business Valuation – Why It’s Critical to the Exit Planning Process

Everyone knows that having a clear plan is necessary for businesses to grow and thrive. Not everyone knows that having an exit plan is also a vital part of a business’ success – especially when the owner wants to exit on his/her own terms. Accomplishing your personal, financial, income and estate planning goals is a process that starts as early as 10 years before you actually plan to exit. Maximizing and protecting the value of your business long before you plan to leave it is a key part of this plan.

The first step in building your company’s value is to know its current worth and understand the factors that determine its value. A business valuation is the starting point – a tool that can help you monitor changes in value drivers and keep a keen eye on the effectiveness of growth initiatives.

How is Business Value Determined?

A business valuation relies on your company’s financial statements and tax returns for the previous four to five years, interim statements for the current year, and copies of forecasts or projections. You’ll need documentation of assets, liabilities, inventory, and clear descriptions of the products and/or services your company offers. Industry, economic and market data will be applied in the valuation process.

Similar to real estate there are typically three fundamental methods for determining business value.  All methods accepted by IRS and the courts fall under one of these three fundamental methods:

The Income Approach calculates value on anticipated future earnings. The method used will differ for companies with stable earnings versus those whose earnings fluctuate year to year.

The Market Approach determines value by comparing recent selling prices of similar businesses using criteria such as industry, geographic location, number of employees and financial performance.

The Asset Approach is based on the fair market value of a business’s total assets minus total liabilities. This method may be applied to asset-intensive businesses or those that are under-performing.

What Factors Affect the Value of My Business?

Many factors, both internal and external, influence the value of your business. Value drivers include:

  • A stable, high-performing workforce
  • Caliber of managers and key employees
  • Sustainable systems
  • Diverse customer base and the strength of customer relations
  • Relationships with suppliers
  • Good facility appearance
  • Realistic growth strategy
  • Key performance indicators (KPIs) in place for financial controls
  • Cash flow, profitability, revenue, low debt
  • Economic and political elements such as interest, tax and unemployment rates
  • Pending litigation or other disputes
  • The lifecycle of your industry
  • Market position and competition
  • The level of dependence the company has on you, the owner
  • Goodwill within the defined community and other intangible assets
  • Attractive business sector
  • Having an exit plan

The business valuation provides the information you need to develop a strategy to maximize and maintain value. It will therefore impact how you do business today and in the future. This strategic tool can help gauge performance, including efficacy of growth initiatives, and signal changes in value drivers.

Exit planning is a complex process, but the sooner you start the greater your success. Don’t delay! Take steps now to chart a comprehensive course to maximize and protect the value of your business so that you are well-prepared financially when the day comes that you step away from your business and into the next chapter of your life.

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