As a business owner, when you transition into retirement, a major factor to account for in the planning process is the market value of the business.
How much you receive for the sale of your business, and how you receive it, will have a significant impact on the funds available to support your overall retirement plan, including your desired lifestyle in retirement, as well as any distributions you may wish to make to family members or charities.
There are many elements to consider in determining the value of a business and a number of valuation techniques used by the experts. To get a solid understanding of the value of your business you will need to consult professionals who have the requisite experience and expertise. This article is intended to provide some basic insights and guidance as to what you can expect from a valuation process.
Experience shows that many business owners will have an inflated view of the value of their business. It’s completely understandable when you consider what it takes to start and grow a successful enterprise. Being an entrepreneur means taking risk, putting it on the line every day, dedicating long hours over many years (otherwise known as “sweat equity”), making the key decisions that can spell success or failure. Similar to how we all tend to value our family home on the high side, the emotional attachment we have to our business will influence our expectation of value.
The reality is, put simply, when it comes time to sell your business it will be worth what an independent third party will be willing to pay for it. In other words, the market will determine the price. So it’s critical to rein in your expectations and understand how the market will value the business. This will alert you to the opportunities to make changes in the business that will influence the value in your favour. So here are some basics to keep in mind:
- The value of a business is most commonly based on a multiple of cash flow. Cash flow is defined as earnings before interest, taxes, depreciation and amortization (EBITDA). The multiplier will vary based on the characteristics of the business and the industry. Generally speaking small and medium businesses will sell for three to six times EBITDA.
- The highest valuations will typically go to those businesses that have the greatest potential for profitable growth and generation of EBITDA. Preparing the business by maximizing earnings growth in the years leading up to the sale and having a clear strategy for sustained growth will support a maximum valuation for the business.
- Valuators will also look at the recent sales of comparable businesses (a competitor perhaps) to arrive at an estimate of value. This can be an excellent indicator of what potential buyers are willing pay at a point in time.
- Potential buyers will be exacting in their due diligence, focusing on key business elements such as management capacity, financial reporting systems, business strategy, and operational efficiency. Excellence in these areas will speak well to the continuity of the business and the capacity for growth.
- The new owners need to know the business can succeed without you. As the business owner, you have been instrumental to the success of the enterprise. Your departure will leave a void and create uncertainty for the buyer unless you have taken steps to “let go” of those responsibilities that can be delegated to others. In some circumstances it will be advisable to groom a suitable replacement for you to take over the senior leadership role in the business.
- The structure of the sale, and the terms and conditions of the agreement can also have a significant impact on the ultimate selling price of the business. To justify the valuation, a buyer may expect you to stay on with the business in a consulting capacity for a number of months to provide management continuity. In some circumstances it may be preferential for you to wind up the company and sell the assets, rather than selling the business as a going concern.
There is much to consider when planning for a business transition. The information contained in this article is an overview that touches on some of the key issues. It’s highly recommended to consult with professional advisors to ensure you protect your personal and business interests.
Ian MacFadden is co-founder and Partner of exitRITE Planning Services. His column appears the first Friday of each month. You can reach Ian at [email protected] or go to www.exitrite.com
