If you said “yes,” then you 1) are better prepared to face the future, 2) will reduce the risk of leaving money on the table when you sell your company, 3) have a better understanding of your strengths, weaknesses and key drivers.
Knowing your value is akin to tallying up your talents and naming your salary – but on a much larger scale.
Many business owners put off valuation until they decide to sell the business or address succession planning. Too late says Miller Cooper & Co.’s Daphne McCoy, Tax Principal, and Deborah Adasiak, Senior Manager – Valuations. They say knowing a company’s worth comes into play any time you ask “what if” questions.
“A business owner should have a general understanding of all her options,” says Adasiak. “Even if somebody is not currently looking for a formal report, it doesn’t mean that starting a dialogue isn’t relevant. It empowers you to know the value of your company.” Adasiak points out that even informal valuations serve as a gauge for companies wondering where they sit in the marketplace, or if they signing on or buying out a partner.
McCoy adds, “Valuations come into play when a key salesperson or successor is invited to buy in or is given some shares in the company. You’ll want to know the tax ramifications.”
Understanding the current value of your business makes navigating sell situations and/or transactions between multiple owners of a business much easier, points out McCoy. “It’s important to know your company’s worth and have a buy-sell agreement. Plan ahead,” she said. “If you don’t know the value, parties may disagree on that number.”
“If you sit down when the relationship is good, it’s easier and it’s on paper,” says Adasiak. “After the honeymoon stage, partners may disagree. People don’t plan for negatives, but knowing your company’s value means also protecting your company and each of your partners.”
Here are examples where knowing your valuation ahead of time makes a difference:
- Gift tax planning
- Estate and succession planning
- Divorce – personal and business
- Corporate planning
- Business sale
- Shareholder and operating agreements
Now, let’s take a quick look at the three basic approaches to valuation.
Asset Approach values each component separately. The asset values are totaled, and the total of the liabilities is subtracted to derive the total value of the enterprise.
Market Approach uses transactional data to help determine a company’s value. These methods might involve private or public company transactions, as well as public company valuation measures using current stock market data. this approach is a good sanity check).
Income Approach is where privately held companies win. This approach combines historical earnings with projections and analyzes working capital requirements for the projection period. It takes into account intangibles like goodwill with customers, deep knowledge of the business, brand, values, industry experience and innovation.
Take estate tax planning as an example. When valuing an interest in a closely held business, valuation is key because a company’s worth is used to measure the interest at date of death. The value is filed with the government and serves as the point of reference. If you say “I think it is three times revenue,” then the IRS will say, “How did you get that?”
The cleaner the valuation, the more proof you have. Most valuation reports produced by Miller Cooper are between 80 and 150 pages, requiring numerous hours. “It’s a process of hide and seek,” said Adasiak.
Gather the Right People – Early
Valuation is not a solo trip. Have the right people involved up front: your investment advisor, CPA, attorney, life insurance agent. Make sure nothing is missed. Know all the moving pieces – from taxes to investments to legal ramifications. Great dialogue and collaboration lead to confident decision making.
McCoy points out, “You know what your house is worth, your personal effects. Why not know the value of your biggest asset – your business?” And if you find out its worth less than what you thought, such knowledge early on gives you time to close the gap.
Advice from a C-suiter from a billion-dollar company usually warrants attention. So when former Infosys CFO, T.V. Mohandis Pai, said valuation is an art, not a science in a speech a couple years ago, his simple words continue to give pause.
It took Michelangelo four years to paint a ceiling. Art takes time. Same goes for valuation.