Why Business Valuations Are Essential for a Successful Exit
Working extensively with business owners, we’ve seen the benefit of proactive exit planning — and the challenges that arise in its absence. A business valuation is an important component of exit planning, serving as a foundation for making informed decisions that shape your future plans and goals. So having an accurate valuation is critical. If you find yourself wondering why obtaining a business valuation is essential, you may consider one of the three scenarios below:
Overestimating a Business’s Value: There is a heuristic in behavioral finance known as the “endowment effect”, which describes people’s biases to assign a higher value to items they own over other similar or identical items. This heuristic can come to play in valuing one’s own business. While strong revenues and profits can certainly justify a strong valuation, other factors such as having a significant customer concentration in a single or few customers, poor industry trends, or key person risk may reduce a company’s valuation. For example, if much of the value of a business is tied to a business owner’s personal relationships, then it could affect the valuation from the perspective of a potential buyer.
Underestimating a Business’s Value: On the other hand, an owner may not be aware of the marketability or valuation in their industry, thereby underestimating the value of their business, and missing a valuable opportunity to capitalize on their efforts of building a successful business.
Lacking Visibility: Many owners may also struggle to see the connection between the value of their business and the lifestyle that selling their business might be able to afford them. This is a very common experience for retirees as well, who oftentimes will need to make a mental shift from supporting their lifestyles with their salary to supporting their lifestyles with withdrawals from their portfolio. We have found that seeing a financial plan that reflects the value of one’s net worth translated into an income stream can provide the clarity and “permission” needed to step away from the enterprise they have spent their life building and enjoy the rewards of their labor.
What Is a Business Valuation, and Why Is It Important?
A business valuation assesses factors like a company’s revenue, earnings history, market conditions in the industry, any intellectual property, and the quality of personnel to calculate the value of your business and ultimately how much you could receive upon selling it. Since the value of the business often makes up a significant portion of the business owner’s net worth,(1) having an objective value of the business is an essential part of the exit planning process, which can then inform estate planning strategies, and attracting potential buyers.
How Often Should You Do A Business Valuation?
While they can be costly, business valuations are invaluable in informing future decisions and giving business owners the clarity needed to step away from their companies confidently. Waiting until you’re ready to retire or sell may be too late to take steps that can help boost the value of your company or align the exit value with your personal financial plan. To mitigate this risk here’s what we recommend:
Most small businesses with limited owners should complete a valuation every 3 to 5 years.
With added complexity or multiple partners, an annual valuation provides consistency and transparency to partners and potential owners.
A valuation also helps inform your succession plan five to seven years from retirement providing you enough time to plan your ideal exit. Read more about steps toward retirement here.
Knowing Your Business’s Worth: How Quantum Helps
There are several factors to evaluate when exiting a business, including knowing what it’s worth and protecting what you’ve built. As a Personal CFO, we guide business owners by creating a comprehensive financial plan that includes forecasts of their cash needs to age 100 and an analysis of different plan scenarios to help them decide their next ideal steps. Our plan helps to address questions such as:
When is the best time to sell for me?
Should I work with a business broker to boost the growth and value of my business?
Which tax planning strategies and sales structure best fit my needs?
What’s the ideal amount I must target to reach my goals and desired lifestyle?
At Quantum, we are committed to guiding our clients through these discussions, ensuring they achieve peace of mind. Contact us today to learn more about how we can help you answer the questions above and plan for your future.
Source
[1] Quantive. “Business Value: How Can Owners Maximize It?” Jan. 30, 2024. goquantive.com.
DISCLOSURE: Quantum Financial Advisors, LLC is an SEC registered investment adviser. SEC registration does not constitute an endorsement of Quantum Financial Advisors, LLC by the SEC nor does it indicate that Quantum Financial Advisors, LLC has attained a particular level of skill or ability. This material prepared by Quantum Financial Advisors, LLC is for informational purposes only and is accurate as of the date it was prepared. It is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment product. Advisory services are only offered to clients or prospective clients where Quantum Financial Advisors, LLC and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Quantum Financial Advisors, LLC unless a client service agreement is in place. This material is not intended to serve as personalized tax, legal, and/or investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances. Quantum Financial Advisors, LLC is not an accounting or legal firm. Please consult with your tax and/or legal professional regarding your specific tax and/or legal situation when determining if any of the mentioned strategies are right for you.
Please Note: Quantum does not make any representations or warranties as to the accuracy, timeliness, suitability, and completeness, or relevance of any information prepared by an unaffiliated third party, whether linked to Quantum’s website or blog or incorporated herein, and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.
For more information about Quantum and this article, please read these important disclosures.
