Exit Planning Step 3 - Business Valuation

The exit plan is now beginning to take shape.  The goals have been identified, including the anticipated timing of exit and the preference for either an internal transfer or an external sale to a third party.  The financial needs have been quantified, including how much is required from the sale of the business to achieve the financial goals.

Now that we have determined where the business owner needs to be upon exit (i.e. the financial needs), the next step involves assessing the business owner’s current net worth, which includes the value of the business.  For many business owners, this can represent a significant proportion of their total wealth.

An independent business valuation is an important benchmarking tool that can be used as a basis for enhancing the value of the business over time.  It can also be used for insurance coverage purposes and for tax & estate planning purposes (two other important considerations dealt with under the comprehensive financial plan in Step 2).

A current business valuation is also useful in the event of a potential shareholder or matrimonial dispute.  A recent article in The Globe & Mail stressed the importance of obtaining and updating a business valuation every two to three years as companies grow and take on other shareholders.  Otherwise there could be a battle over the valuation of the company in a shareholder dispute or divorce.  Having this type of dispute drag on for years could also drag the company down with it. [1]

To illustrate the importance of Step 2 (Financial Needs) and Step 3 (Business Valuation) in the exit planning process, assume a business owner requires $8 million from the sale of the business (net of taxes and other liabilities) and the business is currently worth only $4 million (net of taxes and other liabilities).  This is the shortfall referred to under Step 2 last week. Once this shortfall is quantified, an action plan for enhancing the value of the business prior to exit can be developed and implemented.  The value enhancement process takes time, which is one of the reasons why business owners should begin the exit planning process at least 3 to 5 years prior to an exit.

A professional business valuator can assist with developing a value enhancement action plan.  An experienced valuator will be able to identify the key value drivers that the business owner should focus on to increase the company’s value up to the level identified in Step 2 (Financial Needs).

Next week, before discussing Step 4 (Exit Options), we will discuss the topic of value enhancement in more detail.  Specifically, we will discuss how a business valuator can assist with identifying and prioritizing the key value drivers and what the top 3 value drivers are to most operating businesses.

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1.   Source: "Divorces Mess up Firms as Much as Families", The Globe and Mail, Monday, June 4, 2012, by Wallace Immen.    http://www.theglobeandmail.com/report-on-business/small-business/sb-money/valuation/divorces-mess-up-firms-as-much-as-families/article4228307/