If asked, most business owners would probably say that it’s their goal to sell or transfer their business in order to fund their retirement. And the first question they have is: “How much is my business worth?” They may have a vague idea of what they think it should be worth, but don’t usually have any tangible numbers. More often than not, it’s unrealistically high in comparison to what a buyer would actually pay.
This disconnect is very common. In reality, most owners don’t understand the value of their business or how much money they will need for retirement (we call this the Wealth Gap). And, many are unsure about the steps they need to take to increase business value in order to fund the next stage of their lives.
Why Increasing Business Value Matters
It is not unusual for owners to have 70% to 90% of their net worth tied up in their private company ownership, which makes them highly dependent on the sale of the business to provide the cash they need for retirement. In addition, many owners will have to boost the value of their businesses before they transition or they will not net enough money, after taxes and fees, to fund their retirement.
Let’s look at what constitutes business value, how owners can increase their value, and how they can determine what their business is worth today.
How Businesses Are Valued
Determining business value is not an exact science. There are various methods of calculating value, depending on specific circumstances. For business sales, value is primarily a prophecy of future cash flows for the prospective buyer, whether the business is sold to an internal or external party.
Buyers want to purchase businesses that generate cash so they may receive a return on their investment. Value will be impacted by the size and industry of the business, its growth potential, risk profile, and quality.
Owners generally need a certified business appraisal ($10 to $15,000 cost) for gifting, estate or tax planning, divorce, or implementing an Employee Stock Ownership Plan (ESOP.) But if owners want to sell, they can obtain a cost-effective and simple estimate of value to understand what their business is worth and determine if they will net enough to fund their retirement goals.
What Buyers are Looking For
Buyers pay more for quality companies. If you work hard to grow and improve your business, buyers will be willing to pay more for it. There are many factors that will pique a buyer’s interest and drive the best possible price. While owners tend to focus on the top line, which is important, there are many other critical areas that need to be considered. We discuss these areas in our book, Cashing Out of Your Business – Your Last Great Deal:
- Increasing Revenue & Profits
- Growth Potential
- Clean Financials
- Solid Management Team
- Quality Products & Services
- Strong Sales & Marketing
- Low Risk
- Systems & Processes
How can you determine the value of your business?
We urge all owners to obtain a baseline estimate of value so they can determine just how much they will need to grow in order to exit.
Invest in Planning and Reap Your Reward
As a business owner, you’ve spent countless hours and innumerable resources structuring and negotiating deals, developing innovative products and services, and working to serve your customers – now it’s time for YOU to benefit by making your business exit your best and most successful deal yet.
Minimizing the risk potential in your business takes time, effort, and planning, which is why we recommend you begin the exit planning process at least three to five years prior to your desired transition date. By undertaking this process, you will know how to maximize the value of your business and when to sell (either internally or externally) so you can tap into the value, realize your gain, and get enough money to achieve your goals.
We recommend that all owners create a written Business Ownership Transition Plan (BOTP) as a roadmap to success. This process will help inform owners about the important steps they need to take to increase business value and prepare for the most important transaction of their lives.