Maximizing Your Business Value: Insider Tips for Effective Business Valuation in Exit Planning

Business valuations serve many purposes, but what may be the most important purpose it can serve for a small business owner is exit planning. Exit planning is just that, the process of planning the sale which means you also need time to execute that process to maximize your business value before the sale. Many business owners think that exit planning starts a year in advance but in reality, it takes longer than that. Ideally, three to five years is a good window for planning an effective and strategic exit.

The most important thing business owners should understand when it comes to maximizing their business value, is that value is driven by 2 very important variables; cash flow and risk. These are the 2 foundations of the exit plan because they will determine the value of the company at the time of sale. While other factors contribute to value, these are the two most important factors, and the majority of a business owner's time should be focused on these two areas. During the exit planning process, the primary goal should be to effectively and efficiently determine the best strategy possible to increase cash flow and reduce business risk by as much as possible. 

Understanding Business Valuation 

A business valuation will always identify the specific intended use and intended user(s) of the report. The report cannot be used for anything outside of that nor can it be given to anyone not listed as an intended user. The reason is that there are different types of business valuations for different purposes and those purposes also require different approaches to value; some aggressive and some conservative all depending upon the use.

Some examples of common intended uses, are Business Planning, Divorce, Partner Disputes, Employee Stock Ownership Plans ESOP), and SBA Lending. Each has its own intended use and intended user(s). 

For example, Estate tax / Gift tax are both IRS events intended with the objective of limiting tax burden. In this case, the business valuation will always take a more conservative approach to value with a conclusion that can be supported. When a business owner decides to exit and list the company up for sale the objective will take a more aggressive approach to assure maximum shareholder value is concluded.

Since the value of a company is determined primarily by cash flow and risk, there's no guarantee that one appraiser will conclude a value equal to another appraiser. That's because risk is subjective from one individual to the next. As a result, the purpose of a valuation is to establish a starting point based on reasonable assumptions and facts. As long as the valuation is being prepared by a qualified source (an accredited appraiser), those conclusions should only vary ±10%.

In each valuation, the intended user could be different. Those users could be the shareholders of the company, prospective buyers, prospective investors, or even lenders who may be interested in financing a change of ownership transaction. Since a business valuation represents a cash or cash equivalent value, the intended users will then use the valuation as a baseline and then negotiate or structure the transaction based on specific deal terms. Therefore, there will always be a difference between value and price.

Maximizing Your Business Value: Cash flow and Risk

Key Factors Influencing Maximizing your Business Value 

While many factors contribute to the value of a privately held business, the two main drivers of value are cash flow and risk. Cash flow is the factual component of that equation. Within that component, you will find financial strength and profitability, financial trends, quality of financial statements, and cash flow margins, among others. Risk is the subjective component of the equation. Within that component, you will find various business risks such as dependence on the owner or key employee, concentration and suppliers and customers, economic and industry risk, liquidity and working capital risk, and the company's ability to sustain existing financial performance. The evaluation will only represent the company in its existing state. That means existing financial performance under existing management. What somebody else can do with the company once they acquire it is not relevant in the valuation. The final value conclusion represents 3 variables; total value, tangible value, and intangible value. Intangible value is known as goodwill. So for example, to calculate goodwill, simply take total value and subtract tangible value. Therefore, goodwill is included in the final valuation.

Knowing that there are only really two main drivers of value the impact to value is relatively simple when determining what to focus on. If the main objective is to increase the value of a company, you can approach that from the financial side or the risk side. From the financial side, you can either increase the prices you charge to your customers, decrease your overhead by reducing expenses, or a combination of both. The result from any of those will increase cash flow (and likely cash flow margins as well) which will then increase value. From the risk side, you can focus on reducing owner dependency, building a more diverse customer or supplier base (reducing concentration), adding more products and services, or even restructuring the workforce where every client has a different company contact.

Don't let the complexities of business valuation hold you back. With PeerComps by your side, you can confidently assess your business's worth and make informed decisions for its future. Say goodbye to data dilemmas and hello to maximizing your business value. Sign up for PeerComps today and unlock the true value of your business.