Why Valuation is Imperative in Business Succession

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It’s hard to talk about business succession without talking about business valuation. Valuation is critical to ensuring a smooth transfer of ownership, which can be a complicated and lengthy process. Business valuations can clarify many of the issues inherent in business succession and ensure that all stakeholders involved are treated fairly.

An effective succession plan is well-structured, communicated with key players and followed thoughtfully and strategically. In this blog post, we’ll look at some of the reasons that valuation is imperative in the business succession process.

 

Valuation in succession planning 

Valuation Offers Clarity On the Worth of Your Business Today

If you’ve been building your business over many years, you may have no idea how much it’s worth today. You may have started it with a relatively small amount of capital and steadily expanded when you had surplus funds or attractive opportunities.

Without a business valuation, it can be difficult to know how to approach your succession plan because:

  • You may not have clarity on whether your business is valuable to a third party or what you could offer to a successor who is currently working for the business. 
  • Without a formal valuation, you could vastly under- or overestimate the value of your business, and either of these situations could lead you into trouble.
  • Not only can a valuation provide a figure for how much your business is worth today, it can also help you to understand where this value comes from. 

Perhaps your business is good at generating cash flow, or perhaps it’s an excellent tax vehicle. By understanding where the value of your business lies, you can approach your succession strategically.

 

Valuation Offers Opportunity to Increase Business Value Before You Exit

Skilled business valuators know all about the factors that create value, and they can help business owners to notice the drivers that will facilitate the repositioning of the company for a higher sale price in the future. 

That’s one of the reasons that it’s so important to start your business succession plan early. Given time and expert information, you can build your business in strategic ways so it’s worth more when you are ready to exit. This can help you to achieve your retirement goals and help you to provide for your family after you’re gone.

 

Smooth business succession

Valuation Empowers a Smooth Succession

In many cases, the value of a business is derived from the efforts of a few key employees, and if these employees walk away when the business owner retires, much of the value is gone. This situation can be avoided with a careful succession plan that takes these factors into consideration. 

Selling to key management could be an option for some business owners, but transferring ownership to family members might also make sense. Some business owners, upon learning that their businesses have gained a great deal of value over the years, make the decision to sell to an independent third party. 

 

Succession Planning eGuide

 

Again, without a business valuation, it’s difficult to make informed decisions regarding succession. With a comprehensive valuation, however, you have helpful information on which to base your future plans. The value of your business may be calculated in one or more of the following ways: 

  • Times Revenue Method. With this method, a stream of revenues is applied to a multiplier to show the various streams of revenue over time.

  • Earnings Multiplier. This calculation adjusts future profits against cash flow that could be invested at the current interest rate over that same period of time, so it can offer a very accurate picture of your company’s real value.

  • Discounted Cash Flow. Similar to the earnings multiplier, DCF is based on projections of future cash flows. It also takes inflation into consideration.

  • Book Value. This calculation shows the value of shareholders’ equity of the business; it’s derived by subtracting liabilities from assets.

  • Liquidation Value. This calculation shows you the company’s net cash if everything were liquidated and paid off today.

As you can see, each of these calculations can help you to see your business in a different light. They can also help you to consider the different options you have when you set out to create your business succession plan.

 

Conclusion

Many first generation family businesses do not have a succession plan. The reasons for this are many. Some business owners are simply so busy that they don’t have time to sit down and construct a plan. Others don’t know how to proceed or don’t want to let go of the reigns. Some don’t want to think about retirement or haven’t come across a person who would be a successor. 

If you find yourself in this situation, don’t despair. Simply make a goal to address the problem and get some help if you’re not prepared to do it yourself. Not only can a business succession plan help you to plan for the future, but it can also improve your business today. With a clear direction to follow, you can make confident decisions and prepare your successor to fill your shoes.

For more information about business valuations, succession planning, or any other business issue, get in touch with us at Altus Financial.

Business succession planning guide

Marc Walsh

As a Principal Client Adviser at Altus, I work with business owners of SME’s that have a business vision or a goal they want to achieve. Our clients often work with me to get the best approaches to structuring, cash flow, minimise the risks in their business whilst considering increasing their personal wealth. Let's Connect