Succession Planning: Understanding the Value of Your Business
On Thursday, April 8, David Killion, Transaction Advisory Principal, and Jason Buhlinger, Litigation Support Partner, hosted the webinar, “Succession Planning: What is Your Business Worth?” The webinar, which kickstarted our webinars and educational content on succession planning, discussed how to help business owners plan and prepare for a successful exit.
David and Jason discussed three main exit planning topics: the challenges facing business owners looking to transition, how exit planning can mitigate those challenges and what the exit planning process entails. Read “Succession Planning: The Challenges, Process and Solution” to learn more. They also covered the importance of business valuations in relation to exit planning.
Calculation vs. Valuation
When brought in to look at your succession planning process, your credentialed valuation analyst can provide one of two deliverables: a valuation or a calculation. The valuation is a formal valuation engagement. Your valuation analyst will issue their opinion of value and what they think the business is worth. They will also be able to testify to this value if a dispute arises.
Alternatively, a calculation engagement is higher level and more consultative. In a calculation engagement, your valuation analyst would not issue an opinion of value like they would in a valuation. Instead, they typically work with management to come up with a rough estimate of value and agree on the approaches and methods to be relied upon.
Typically, for succession planning purposes, whether you use a valuation or calculation comes down to whether you planned for the exit or you didn’t. If you don’t plan for it, more often than not a full valuation is going to be performed.
Methods of Valuation
When you do a full business valuation, there are typically three different methods: the asset approach, the income approach and the market approach.
The asset approach can then be broken down further into two different methods: the book value method and an adjusted net asset method. The book value method is a matter of taking a balance sheet, looking at the book value of the equity, and determining the value of the business according to the book value of the equity. The adjusted net method, which is far more common, looks at the assets line by line and then adjusts each asset to fair market value. The thought under the asset approach, particularly adjusted net asset method, is that a prudent investor or an owner likely isn’t going to willingly depart from their ownership for any less than the adjusted net asset method.
When it comes to an income approach, there are two different metrics your valuation expert can use: a capitalization of earnings and discounted earnings. In an income approach, your expert is looking to understand how much cash flow the business is going to generate into perpetuity and how much profit it is going to generate for ownership.
The market approach, then, is a hybrid of the income approach and the asset approach. It looks at the cash-flow-generating capability of the business through EBITDA or a revenue multiple depending on the industry norms. The market approach will look at a guideline public company method or a comparable private transaction method.
Purpose and Price vs. Value
It’s important to start the valuation process as early in the exit planning process as possible. Our valuation experts work to determine three main items:
- Whether the business is saleable and approximately what it should sell for
- A starting point for negotiation
- Characteristics that add and detract from the value of the business
The first item to evaluate is whether the business is saleable and, if so, the amount it should sell for. Not all businesses are saleable. For example, a CPA business run by a man who has been the only employee for the last 30 years is going to be much more difficult to sell than a practice with multiple CPAs where there’s not as much business tied directly to working with one specific person.
Your valuation expert will also try to determine a starting point for negotiation and the characteristics that add and detract from the value of your business. To determine this information, the expert will generally use a market approach and look at what other companies have sold for in the same industry. It’s important to note that the valuation expert would not issue an opinion of value; rather, they are looking to determine what the business is worth and what you can expect as a starting price for negotiation. Price does not always equal value. The goal of a successful succession plan is to reach an equilibrium where the price of the business equals its value. You want the selling price to be as high as you can get it and you want the buyer to realize as much value at that price as they can.
Value Drivers and Key Takeaways
Finally, there are two value drivers to keep in mind as you consider exit planning: early valuations and the difference between sweat equity and transferrable equity.
The best way to protect against an unknown exit or an unanticipated exit is to make sure your operating agreements and your buy-sell agreements are buttoned up and that they’ll be acceptable to all parties as time goes on. It’s also critical to ensure that everyone involved in the transaction is comfortable with all potential outcomes if the agreement needs to be utilized.
It’s also important to remember that hard work does not always translate into saleable value. If you compare a business managed by an owner who puts in 13-hour days and handles all aspects of the business versus a business with a much more hands-off owner that hires other staff to oversee various parts of the business, the latter quite possibly could realize a higher sale price because it’s more autonomous, more easily transferable, and has more people in place to efficiently run the organization.
If you’re interested in hearing more about this topic and were unable to attend the live webinar, click here to access the recording.
If you have questions or need assistance with your business valuation, please feel free to reach out to Jason Buhlinger, Forensics and Business Valuation Partner, at 314.983.1310 (JBuhlinger@bswllc.com).