It probably won’t happen today or tomorrow, but at some point, you’ll leave your company. Ideally, you’ll walk away wealthy—or at least wealthier than you are right now—ready to dive into retirement, the launch of your next business, the beginning of your career as an investor, or whatever the next stage of your life holds.
But exits don’t always happen the way we hope and dream they will. There are unavoidable crises, downturns, and other economic realities to contend with. Companies fail; in fact, fewer than half of small businesses in the US survive beyond a decade.
All of which is why smart exit planning is essential. Conventional wisdom holds that a founder should start thinking about their exit strategy from day one. You might not know exactly how you’ll leave your business, but you should be speculating about your options (Sale? Transfer of ownership? IPO? Management buyout?) as well as the general timeline (5, 10, 20 years?) during which you’ll be involved in the organization.
Most important are your financial goals. How much money do you hope to have when you leave? How will you ensure you walk away with what you deserve? At the core of these considerations lies a deceptively simple question:
How Much Is Your Company Worth?
How much is worth today?
How much will it be worth when you exit?
Who decides what it’s worth—and how do they decide?
To get the answers, you’ll need to get a valuation. A business valuation is an estimate of your company’s current asking price, or of the financial value of your stake in the organization. It’s a number that tells you how much you could expect to make if you put your ownership in the company on the market right now.
Unfortunately, this isn’t something you can calculate accurately by yourself. Valuation is both a science and an art—and it’s best left to third-party professionals. There are just too many factors to consider and too many (somewhat subjective) judgments to make on your own:
- What do current earnings say about the present and future value of the business?
- What is the business’s growth potential? How likely is it to achieve that potential?
- How does the business compare to other, similar entities? How is it different?
- What’s the business’s risk profile?
Sure, you’re probably thinking about these kinds of concerns practically every waking moment of every day, but keep in mind that you’re limited by your proximity to your business. You don’t know what you don’t know. You may not know what other businesses like yours have sold for and why, or even what businesses are truly similar to yours. You may not be able to see the pros and cons a buyer would see, or what makes your company valuable and/or risky relative to their interests.
Or, you might fundamentally disagree with how an outsider would assess your business. Theoretically, even if you could determine the precise value of your company, who’s to say someone else would see eye-to-eye with you? Why should they believe you?
Ultimately, the value of your business is up to the market. It’s not what you think your ownership should sell for, but what someone would actually pay for it. This is why, when it comes time to exit their businesses, owners hire valuation specialists to estimate what they can realistically expect to see from a sale.
Getting a valuation is an important step of any merger or acquisition, but can also help guide the timing of other exit strategies, such as employee stock ownership plans (ESOPs). Basically, your goal is to maximize your payout by leaving the company when value is high. A valuation tells you whether it’s truly time to leave, or if you need to continue building your bottom line.
Why Are Valuations So Complicated?
This is all pretty straightforward in theory. In practice, however, the valuation process can be complex, unpredictable, and frustratingly opaque for founders and owners.
It’s imperative to find the right valuation specialist—someone experienced, someone you trust, someone who communicates clearly—and to discard any assumptions you have about your business that are not grounded in fact. People close to a business are frequently surprised by the numbers independent valuations come up with. Your company may be worth less than you think, and it can take significant time and effort to understand why that is.
Here are a few reasons valuations are so complicated:
Variables: Valuations are based on multiple metrics, such as EBITDA (earnings before interest, taxes, depreciation, and amortization), market capitalization, price to earnings ratio, discounted cash flow—the list goes on—layered on top of each other. The math can get overwhelming, fast. And there’s no standard formula.
Different valuation methods: Every valuation professional has their own style and uses different approaches depending on the business, industry, and market in question. This can lead to significant disparities in value between businesses and even between valuations of the same company.
Jargon: Valuations have a significant learning curve for non-specialists. You’ll likely need to learn new terminology, as well as new ways of understanding your business over time and outside of the organizational vacuum. One common source of confusion is the concept of multiples, which indicate a company’s growth potential relative to the context of its market—even investment bankers often get this one wrong.
Larger economic factors: Major economic events such as recessions certainly impact the value of a business, but so too can other external issues. Technological disruptions, trade agreements, political developments, environmental disasters, local real estate prices—there are countless factors that can increase or decrease what the market thinks an organization is worth. Valuation professionals need to weigh these factors and analyze which do and don’t bear on the valuation equation. This is another largely subjective determination among many.
What Can You Do to Maximize Your Valuation?
As complex and variable as valuations are, the value of your company isn’t totally outside of your control. Here are a few ways to make sure you get the high valuation you and your business deserve:
1. Lock down your key value drivers. Whether it’s your people, technology, intellectual property, contracts, customer base, or a combination thereof—or something else entirely—protect it and nurture it until you’ve completed your exit.
2. Keep your cash flowing. Cash flow is the lifeblood of your business. It not only ensures your organization’s survival but demonstrates good health to a valuation specialist, buyer, investor, or another external appraiser.
3. Make sure your financial documents are complete and up-to-date. This helps a valuation professional determine the value of your company as accurately as possible. The more objective information you can provide about your organization, the better.
4. Optimize your taxes. The tax consequences of an exit can be devastating if you don’t plan ahead. Work with a financial expert now to minimize your tax liability and ensure a profitable exit when you eventually leave.
5. Consider your timing. It’s important to get a valuation only when you and your company are ready. Going the process too early is a waste of time and money—it won’t tell you much about what you can actually expect when it’s time to exit. On the other hand, depending on the nature of your business and your exit strategy, it may be worthwhile to get a preliminary valuation. Your financial partner can help you determine the right time and approach.
Have questions about business valuations? Want to maximize your value or discuss your exit strategy with an expert? The team at inDinero is here to help.
Get tax, accounting, and strategic financial guidance you can trust. Talk to an expert.
Quick Note: This article is provided for informational purposes only, and is not legal, financial, accounting, or tax advice. You should consult appropriate professionals for advice on your specific situation. inDinero assumes no liability for actions taken in reliance upon the information contained herein.