Preface: When a business transition occurs, approximately forty-five percent of owners will sell to a key employee or family member, and fifty percent will sell to an outsider; and roughly five percent of the businesses will not sell or transact at all….here’s what you need know for your future transition.
Your Successor Looks at Your Business as an Investment
Credit: Donald J. Sauder, CPA |CVA
Small business organizations in the United States contain both future opportunities and risks for enterprising talent and business owners alike. First, seventy-five percent of these small business organizations have a majority owner that is fifty years of age, or older. For most business owners in this majority it represents a business risk that statistically says fifty to seventy-five percent of the owner’s retirement net worth is in their business valuation or the fair market transaction value of the business. Yes, most of these business owners factually have only ten to twenty-five percent of their net worth in investment assets outside the business e.g., an investment portfolio or 401k plan. Therefore, in many cases, harvesting that business value is crucial to the small business owner and their family’s financial future. Business value is much like an agricultural crop of wheat or corn, a successful harvest is not guaranteed but always anticipated.
“One of the common, substantial, and problematic factors in harvesting business value is the expectation of that business’s fair market transaction value to a buyer i.e., the appraisal.”
When a business transition occurs, approximately forty-five percent of these owners will sell to a key employee or family member, and fifty percent will sell to an outsider; and roughly five percent of the businesses will not sell or transact at all. Of those businesses , fifty percent plan to transition shares within three years and seventy-five percent plan to transition in ten years.
Beyond statistics, if you are one of these small business owners in the majority, preparing and planning your business transition is certainly advised and necessary. One of the common, substantial, and problematic factors in harvesting business value is the expectation of that business’s fair market transaction value to a buyer i.e., the appraisal. While this variable changes from year to year based upon net earnings, cash flows and EBITDA, customer concentrations, revenue propellers, and other factors relevant to the future probabilities of discretionary earnings in the business, tracking and benchmarking that value helps set proper transition expectations.
Setting appropriate expectations early is a keystone of successful ownership transition. Strategic business owners will value their business at least twice before beginning a transition of ownership. This helps benchmark value expectations and sets a realistic foundation to optimize appraisal values for a future transition of business ownership.
“Too often, for most business owners, they approach business valuation as a second step in the transition process.”
There are multiple business valuation metrics, approaches and variables in appraising an accurate and fair market business value. For instance, the Asset approach will arrive at an entirely different value than say, an Income approach or Market approach, and a Market approach is subject to likewise variables in comparisons of product, market depth, and business locale. A realistic business valuation will include at least two comparisons of value in the report, e.g., an Income and Market approach.
Business valuation is more than financial analysis; it is an art and a science that requires appropriate expertise to obtain accurate fair market transaction appraisal value. It is at the capstone, a prophecy on the future cash flows of the business, discounted to a current value.
Too often, for most business owners, they approach business valuation as a second step in the transition process. It’s alike to savoring a large ice cream cone on very warm summer evening, i.e. they forfeit the opportunity to maximize appreciation [value] on the sale of the business (the investment) with proper planning and performance improvements that can sometimes substantially increase harvest yields, i.e., the business value.
End of Segment I. To Be continued.