One Tweak That Can (Instantly) Add Millions To The Value Of Your Business

If you’re trying to figure out what your business might be worth, it’s helpful to consider what acquirers are paying for companies like yours these days.

A little internet research will probably reveal that a business like yours trades for a multiple of your pre-tax profit, which is Sellers Discretionary Earnings (SDE) for a small business and Earnings Before Interest Taxes, Depreciation and Amortization (EBITDA) for a slightly larger business.

Obsessing Over Your Multiple

This multiple can transfix entrepreneurs. Many owners want to know their multiple and how they can jack it up. After all, if your business has $500,000 in profit, and it trades for four times profit, it’s worth $2 million; if the same business trades for eight times profit, it’s worth $4 million.

Obviously, your multiple will have a profound impact on the haul you take from the sale of your business, but there is another number worthy of your consideration as well: the number your multiple is multiplying.

How Profitability Is Open To Interpretation

Most entrepreneurs think of profit as an objective measure, calculated by an accountant, but when it comes to the sale of your business, profit is far from objective. Your profit will go through a set of “adjustments” designed to estimate how profitable your business will be under a new owner.

This process of adjusting—and how you defend these adjustments to an acquirer—is where you can dramatically spike your company’s value.

Let’s take a simple example to illustrate. Imagine you run a company with $3 million in revenue and you pay yourself a salary of $200,000 a year. Further, let’s assume you could get a competent manager to run your business as a division of an acquirer for $100,000 per year. You could safely make the case to an acquirer that under their ownership, your business would generate an extra $100,000 in profit. If they are paying you five times profit for your business, that one adjustment has the potential to earn you an extra $500,000.

You should be able to make a case for several adjustments that will boost your profit and, by extension, the value of your business. This is more art than science, and you need to be prepared to defend your case for each adjustment. It is important that you make a good case for how profitable your business will be in the hands of an acquirer.

How Can Employees Buy A Company?

In some cases, employees are capable of successfully operating a business, but lack the capital to acquire it. This may become the last resort for a seller, who takes a note rather than close the doors. This approach leaves the seller in the role of silent partner, hoping that the employees can maintain the business well enough to pay the debt.

With some reasonable planning, selling to employees can be more pleasant, and better for both buyer and seller than seeking an outside third party to purchase the business. Pricing becomes less of a negotiation, since both buyer and seller agree on the same valuation methodology well before the transaction. The nominal price of the business is less important than the owner’s needs for retirement, and employees’ ability to qualify for financing. 

Owners who develop an exit plan for selling the business to employees can begin the transfer while they still hold control of the company. The employees gradually assume substantial ownership. After they learn the responsibilities of managing the company, they can qualify for a loan to purchase the remainder of the ownership. In these cases, the owner does not surrender decision making until his or her payment is completely secure. 

Where an owner seeks retirement funding in excess of what the business is worth today, employees can earn their equity rights by achieving specific sales goals and profitability objectives. This gives them a powerful incentive to assume responsibility for building a business independent of its current owner. 

If you believe that you have employees who are capable of operating the business without you, please contact us. Planning for an employee transfer may take some time, but can have terrific results in building a win-win situation for everyone.

 

© 2014, MPN Inc.

Importance of Estate Planning for Business Owners

It is not uncommon for the business to be the largest asset in a business owner's estate, while also being the primary source of income for their family.  As estate planning is essentially taking control of how property is to managed during life and distributed and transferred at death, a business owner cannot do exit planning without estate planning, or estate planning without exit planning.  Exit goals, such as transferring a business to children, always impact an owner's family and estate.

An example of where an owner's estate and exit plans intersect would be in the area of business continuity.  Sarah, a widow of five years, owned a large women's apparel retail store.  She started the business twenty-five years ago and remained as sole owner as the business continued to grow and realize success.  Sarah's daughter Sue graduated from college three years ago with a degree in design, and both she and Sarah had a vision for Sue eventually taking over the business. Sarah's son Jack, and other daughter April, have no involvement in the business.  

Tragically, Sarah passed away suddenly a year ago causing great distress to her children.  The fact that she passed without having finalized her estate plan resulted in even more hardship for her family.  It was one of those things that she knew she needed to do, but just never could "get around to it" due to the day-to-day trials of running a thriving business.  She had a will but it hadn't been reviewed in over fifteen years.  

The consequences of not having designed and coordinated an estate and exit plan, Sue did not end up owning the business as both she and her Mom desired, the business was sold at a deep discount due to uncertainty among employees and customers, other assets also had to be sold to pay high taxes and estate settlement costs, and there was resulting tension between the siblings due to a disorderly distribution of assets.  This is a short list of the potential consequences of deficient and disjointed estate and exit planning for a business owner.  

Like our fictional character Sarah, most business owners lead busy and full lives.  They can understand that estate and exit planning are important, but it can be difficult to plan the time to make it happen as it represents even more work.  So, it can be very easy to procrastinate.  

The focus of an impactful estate plan is not simply death but also the arrangement of assets (ownership and utilization) in ways that will help estate holders achieve financial goals in a tax efficient manner during life while providing for survivors’ needs and the disposition of property at death. A successfully implemented estate plan can:

  • Minimize estate taxes and estate settlement costs

  • Ensure that cash is available to pay estate taxes and costs

  • Provide for an orderly transfer of assets that meets the estate owner’s objectives and intentions

  • Preserve assets during life

  • Protect a business and ensure its successful transfer or sale

  • Provide peace of mind and family harmony

A well-thought out and executed estate plan, as part of a comprehensive exit plan, will be instrumental in ensuring that the right person takes over a business when the current owner dies. Other issues that would be addressed in a comprehensive estate plan would include the appropriate business valuation, equitable estate distribution among children, a properly drafted buy-sell agreement, tax and philanthropic planning.

As a business owner, it is wise to regularly review your estate plan to ensure that it represents your current desires and goals for your personal and business asset distribution. Please contact us if we can be of service to you in the review of your estate plan.

Wealth Management & Exit Planning for Business Owners

Recently I was invited to conduct a seminar on the critical elements of a successful exit plan for business owner clients of Charles Schwab here in the DC area. First, I applaud Nikki Arwood and Joy Stephens who represent Schwab locally, and their efforts to serve business owners in this most significant planning area for business owners. Business owners are often neglected by the wealth management community as the business is commonly (not always) their largest asset, and not a managed portfolio of stocks, bonds, and mutual funds. If you’re a business owner, you’d be well-advised to employ a financial advisor who is proactive around accurately factoring your future plans for the business in your plan for managing your wealth.

You see, if financial advisors or wealth managers are to effectively serve business owners in managing their wealth, then the eventual sale or transfer of the owner’s business also needs to be accurately factored into their financial planning and overall plan for wealth management. For example, a financial planner may not factor in the value of the business, or, if they do, they may use an inaccurate valuation of the business. It is not unusual for a financial planner to ask, “What value would you put on your business?” and for the owner to respond with a subjective number that is most often inflated. This of course can make all financial planning worthless if indeed the business is to play a key role in the owner’s future financial security and goals.

So, impactful wealth management for business owners has to include at least the following elements of exit planning:

  • Clarifying what “exit” means to the owner. For example, does the want to leave entirely at some point, or die at their computer with their boots on?

  • Clarifying goals (financial, values-based, legacy goals) and what role the business needs to play in attaining their goals. For example, will they need to get financial value and/or income out of the business eventually, and if so, how will they do that?

  • A financial needs and gap analysis with an accurate valuation of the business. Is there a financial gap in what the owner wants to do, and what financial security means for them, and what they currently have accumulated? What role does the future value of the business need to play in that calculation? Meaningful planning requires accurate data.

  • Personal risk management: asset protection, insurance planning, tax planning.

  • A current estate plan to include and appropriate philanthropic or charitable planning. An owner cannot do exit planning without doing estate planning.

  • A plan to preserve the value of the business (typically an owner’s largest asset), having it continue during unexpected events of permanent disability, death, or life transitions (business partners).

  • An appropriate plan for managing financial assets as the result of sale or transfer.

Exit planning is wealth management for business owners. It involves preserving, building, and accessing the value of your largest and most complex asset.

Contact us at [email protected] for further discussion or information.

How To Avoid Disappointment When It's Time To Cash Out

How do you avoid not being disappointed with the money you make from the sale of your company?

Perhaps you’ve heard that companies like yours trade using an industry rule of thumb or that companies of your size sell within a specific range, and you want to get at least what your peers have received.

While these metrics can be useful for tax planning or working out a messy divorce, they may not be the best ways to value your company.

The Only Valuation Technique That Really Matters

In reality, the only valuation technique that will ensure you are happy with your exit is for you to place your own value on your business. What’s it worth to you to keep it? What is all your sweat equity worth? Only when you’re clear on that will you ensure your satisfaction with the sale of your business.

Take Hank Goddard as an example. He started a software company called Mainspring Healthcare Solutions back in 2007. They provided a way for hospitals to keep track of their equipment and evolved into a slick application that hospital workers used to order supplies.

Goddard and his partner started the business by asking some friends and family to invest. The business grew, but there were challenges along the way: Goddard had to fire his entire management team in the early days, product issues needed to be solved and operational issues needed to be resolved.

At times, it was a grind, so when it came time to sell in 2016, Goddard reasoned that he had invested more than half of his career in Mainspring and he wanted to get paid for his life’s work. He also wanted to ensure his original investors got a decent return on their money.

He was approached by Accruent, a company in the same industry, who made Goddard and his partners an offer of one times revenue. Accruent had recently acquired one of Goddard’s competitors for a similar value, so presumably thought this was a fair offer.

Goddard brushed it off as completely unworkable. Goddard had decided he wanted five times revenue for his business. Even for a growing software company, five times revenue was a stretch, but Goddard stuck to his guns. That’s what it was worth to him to sell.

A year after they first approached Goddard, Accruent came back with an offer of two times revenue and, again, Goddard demurred.

Mainspring had developed a new application that was quickly gaining traction and he knew how hard it was to sell to the hospitals he already counted as customers.

He told Accruent his number was five times revenue in cash. Eventually Goddard got his number.

Being clear on what your number is before going into a negotiation to sell your business can be helpful when emotions start to take over. Rather than rely on industry benchmarks, the best way to ensure you’re not disappointed with the sale of your business is to decide up front what it’s worth to you.