In an earlier post we discussed the important step of making the decision to begin the succession planning process. Once you have made the decision to begin the process, knowing the value of your business is the second crucial step in the transition plan.
Typically 50-70 percent of a business owner’s net worth is tied up in the business. Having solid data on what your business is worth will help you make management decisions that help you grow your biggest investment – your business – over time, just as you would grow the funds in your stock portfolio. This “investor’s mindset” might include identifying potential risks to the business and minimizing them, looking for sustainable growth in your product or service lines and keeping a close eye on cash flow in the business. Certainly the earlier and more frequently you conduct a valuation of your business, the better informed you’ll be when making management decisions that will impact your company’s value in the future.
The value of your business becomes even more important as you get closer to transitioning the business. Knowing the value of the business will help you realistically plan for retirement or other ventures after you leave the business. Having the valuation information will also greatly help you and your financial team plan for tax implications and investment strategies as you go through the transition.
It is easy for a business owner to develop an idea of what they think their business is worth. However a valuation that reviews the financial statements and comparable businesses can result in a realistic but totally different number.
I once met with a business owner who told me she had her succession plan completely worked out. She was going to tell her business to her son for $2.5 million. When I asked her how she arrived at this value, she said “because that is the amount I will need to maintain my country club lifestyle.” When the actual business valuation was completed, her business was actually worth $750,000. She had to dramatically change her expectations for her life after the business transition.
Don’t be blindsided by unrealistic expectations about the value of your business. Invest in a business valuation. Use the valuation to make management decisions that will enhance the value of your business before and during the transition process. This information will also greatly aid you in determining your retirement and lifestyle expectations following the business transition as well.
In a future post, we’ll look at the various options available to transition a business as we work our way through the steps for successful business succession planning.
For additional information about succession planning for your business, please talk to your accounting professional.
Follow Tim McDaniel on Twitter @GrowYourValue