What’s Your Business Worth? Why It’s Important to You!
Let’s begin with the second statement first: Why is the value of your privately-owned business important right now, even if retirement is years off? This question is as important to business owners operating in the healthcare industry, including equipment provider and servicers, if not more so, than any. According to Kalorama Information, a market research firm, the medical device industry is forecasted to grow more than 4% to 6% over the next few years, but no one really knows how the system will perform until the Obama healthcare reform plan (or any healthcare reform plan) is finalized. The healthcare sector as a whole is currently in a state of flux with impending historical changes and challenges, which can cause large swings in healthcare business valuations.
If your business is in growth mode and there is no compelling reason to monetize the value of your business in the next five or more years, then your concern, legitimately, should be to figure out how to best handle the coming changes in the market place, redeploy capital to continue growing the company and build the value of your asset(s).
If your company, however, is mature or you expect to enjoy the fruits of your life’s labor within the next five or so years, a plan to monetize the value of your company – ordinarily a rigidly illiquid asset and even more so in the current healthcare industry environment — should be a priority. According to a 2010 PriceWaterhouseCoopers (PWC) Trendsetter Barometer report 72% of private-company CEOs plan to unlock the capital tied up in their business; 38% say they will do so over the next five years; and 60% of small private business owners say they will monetize via a sale in a reasonably short term. And yet, consider these statistics, from another PWC report:
- Only 22% of small, private company CEO’s have done a great deal of succession planning, 26% have done some, 24% have done little, and 19%, virtually none (the balance did not report).
- 39% of CEOs have a likely successor in mind, but nearly half (45%) have identified no successor (the balance did not report).
How does all this translate? If you’re a small business owner you may very well be the millionaire next door but you probably have approximately 65% to 95% of your total net worth tied to your business. In an industry with structural changes looming, which is likely to introduce new business models, competitors, and new winners and losers, this may not be wise.
To bring this into the realm of everyday living let’s assume a simple hypothetical. If your $10 million revenue business yields an owner benefit of $500,000 per year (a generous assumption, since the national average salary for small business owners is between $100,629 and $268,841 a year according to a Payscale.com Dec 2010 survey), you will need a $6.25 million nest egg generating an 8% annual return (another generous assumption) to maintain your lifestyle without dipping into principal savings. Admittedly, a crude hypothetical plan but it makes an important and reasonable point no less: The plan to monetize the value of his or her business will be the single most important transaction of a business owner’s life.
And then, once the decision to plan for an exit has been made, it only gets more complicated. Will you sell to a third party? Transfer ownership to a family member? Is an ESOP a good alternative? How do you not underestimate the value of the business and leave money on the table? How do you not overestimate the value and possibly create buyer’s remorse? What about the operating issues – customers, employees, vendors, and competitors? How long does the process take?
Where to begin?
Like any analysis you need a clear starting place and a desired endpoint. Where am I now? Where do I want to go? (The desired end point is a discussion for a wealth advisor, a topic which is not addressed in this article).
The business valuator, a financial professional which may also be your accountant, collects and analyzes data — historical financial statements, forecasted financial statements, tax returns, depth and experience of management, type and stability of business operations, industry information, competition, economic statistics, market trends, risk factors, and many other data sets. With this information, the valuator then analyzes and values the business based on various methodologies, which for simplicity purposes, can be categorized into net asset-oriented and earnings-oriented methods. Often, the final valuation is based on an average of two or more methods.
How meaningful is this valuation in exit planning? It’s critical when the transfer of ownership is to an internal participant. That is, to family members, partners, management teams, and/or employees. These transfers often occur in a non-competitive negotiation — the value of the business is based on the report of the business valuator, not the marketplace between a willing buyer and seller. The report is recognized for tax purposes, estate planning, liquidation, contractual agreements and serves as a good beginning for exit planning. You need to know how much your asset is worth in order to protect it and sell it.
However, in the marketplace a business is only as valuable as what a buyer is willing to pay for it. An intermediary, usually an investment banker or a broker but occasionally a lawyer or the business valuator, manages the process of marketing, negotiating, and selling the business. The intermediary certainly uses the quantitative analysis described above but different buyers can arrive at wildly different valuations. A new market entrant is likely to pay more for a company than a direct competitor. The new market entrant needs everything the company has to offer – management, revenue, customers, vendors, processes and procedures, distribution, among others. The direct competitor may only find value in the revenue and customer base, and therefore is not willing to pay a fair market valuation, let alone a premium. In this dynamic the formal business valuation is less important, if no buyer accepts the price.
So the answer to the question — What’s your business worth? – depends on your exit plan. How much do you need to meet your personal financial objectives? Who is the likely successor of the company? When do you want to retire? Regardless, the sale of the business is likely to be the single most important asset of the owner’s financial net worth and deserves serious planning. A business valuation is among the first steps necessary to begin the proper planning.
