The DUFF TORNEY Team

Michael Torney, CFP, J.D., LL.M. 

Most owners work constantly to build their businesses. They are always seeking to find new customers, increase revenues and maximize profits. Yet, many don’t know how much their business is worth. Is it worth $10 million? $25 million? And how is the value determined? 

To answer this question, owners usually need an outside firm to conduct a business valuation. While this is a critical part of selling any business, it’s valuable for other reasons, too. Once you know where the business needs improvement, you can take action to try and increase its value. And while many owners wait until they are ready to sell before finding out how much their company is worth, at that point, it’s often too late to make any changes.  

This blog is aimed at helping owners understand how business valuations work, the benefits of getting it done before you are ready to sell, and how to select a person or firm to conduct the valuation. 

What is a business valuation?

It’s an objective assessment of your business’s fair market value based on its current condition. It provides a complete summary of the business, its financial health, structure, and future earning potential. 

How does business valuation work?

A qualified professional analyzes your company’s financial statements and considers the value of comparable businesses, industry ratios, and other quantitative and qualitative information. They will also evaluate the quality of the management, the stability and growth prospects for your customer base, and other factors that help make up a successful business. 

Why it’s important even if you have no plans to sell.

Getting a business valuation done more than five years before selling can provide multiple benefits. It can uncover opportunities to grow revenues, identify areas where you can cut costs, bring out issues a potential buyer would be wary of, and identify gaps in cash flow along with ways to operate more efficiently.  Valuations can even include information on the taxation of the sale – this is important information for the business owner’s personal financial planning. 

A valuation can also make it easier to raise capital or obtain a bank loan. Presenting a lender with a professional business valuation, including detailed financial statements, will often help streamline the process. A detailed business valuation can even help determine the amount of insurance coverage you need.   

With a business valuation in hand, your financial advisor can create a comprehensive financial strategy long before you plan to sell. Because a business usually accounts for the bulk of the owner’s net worth, determining a reasonable value is critical retirement planning. It also lays the groundwork to both protect and transfer that wealth to the next generation.  

In addition to building an investment portfolio to maximize its return and minimize risk, the advisor can also address other items. These include the right kind of life insurance; a buy-sell agreement, which addresses events that trigger a transfer of ownership in the business, and trusts. They can also review and implement retirement plans and other strategies in an effort to lower your taxes. 

When planning to sell in five years or less.

Owners with children often want to transfer ownership to their children or other family members. These discussions should begin at least five years before you decide to exit to work out several details about the future. 

If one or more children decide they want to own the company, you can begin making financial transactions now and decide how much to sell or gift to family. For example, owners can make tax-free gifts of $17,000 in 2023 to as many individuals as they choose each year before they leave. 

Hiring an estate planning attorney is critical to managing the transition. For example, if you wish to retain control of the company and transfer non-controlling shares to your children, creating voting and non-voting shares might be an option. Here, you would make annual gifts of non-voting shares while retaining the voting shares. Your attorney will work with you to customize a plan that meets your needs and desires. 

Even if keeping the business in the family is your objective, you should continue to maximize the company’s value as a hedge if your plan doesn’t succeed.  

Start by examining the quality of your management team. Any interested buyer may want to know that an experienced management team is capable of seamlessly operating the company. Next, analyze the quality of the company’s financial statements. Potential buyers will often hire an accounting firm to analyze the quality of your earnings, and they will likely review the company’s financial and legal records to ensure all information is valid. 

How to select a valuation provider.

Unlike many industries, the business valuation industry isn’t regulated. However, some organizations offer valuation credentials. The three most prominent are The American Society of Appraisers (the “ASA”); The American Institute of Certified Public Accountants (the “AICPA”), and the National Association of Certified Valuators and Analysts (known as “NACVA”).  

Because business valuation firms are not necessarily all equal, be selective when deciding on a firm.  Ask a lot of questions about the types of clients they serve.  Ideally, you want a valuation provider who is intimately familiar with factors such as: 1) your industry; 2) the size of your business; 3) the type of business you operate; and 4) geographic considerations that might impact the price of your business.  Hopefully, the valuation expert has completed many valuations of your type of business. 

To conduct their business valuation, a firm will generally use at least one of three traditional ways to determine value. While each approach has its own distinct methods and can vary by state regulations, here is a broad definition of each: 

• Assets, which focuses on the balance sheet and is often used for holding companies or asset-heavy firms that don’t generate significant cash flow relative; 
• Market, which compares your company’s performance to either a publicly-traded company or a closed transaction;  
• Income analyzes a company’s growth prospects and projects the company’s future income. 

A business valuation can provide owners with significant benefits for the future of their business and retirement planning. If you have questions and would like to learn more, contact our team at DuffTorneyteam@monetagroup.com. We work with many business owners and offer a free consultation on how a business valuation can help you.

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