Many successful entrepreneurs launch and grow their businesses with an end in mind — and that end is often the sale of those businesses.
But when it’s time to sell, how do they know what the business is worth?
Like the entrepreneurial journey, the voyage to answering this question is potentially wrought with pitfalls. Fortunately, planning and expert assistance can calm the waters.
Identifying risks
One issue owners sometimes face is thinking their business is worth more than it actually is. This can stem from a personal bias — they understand all of the hard work and dedication that went into the business, which can inflate its value in their mind — but it can also be indicative of a failure to clearly identify post-sale risks.
Owners can overlook these risks because they’re busy running the business, whereas the risks are clear to potential buyers:
- Will customer relationships exist after the sale?
- Is intellectual property protected?
- Are competitors more viable than previously thought?
- Is the business built for the long-term, or will value exit with the owner?
This evaluation can reveal that owners have well-paying jobs rather than salable businesses. However, with enough lead time, the groundwork for a successful sale can be laid.
Internal considerations
A business’s operations affect its valuation, as buyers examine operational and financial strategies. For instance, does the business maximize profits or aim to minimize taxable income? (A company engaging in a tax minimization strategy would list expenses such as charitable donations and company vehicles as discretionary expenses. A company maximizing profit would not list them as such.) Business strategy affects financial information, and perhaps buyers’ offers as well.
Another key element is owner involvement. Contrary to what many entrepreneurs want to hear, sometimes passive owners are more objective and realistic about the business’s value, risks and the strategic implications involved. Buyers can factor ownership roles into their offers.
Preceding the sale, a thorough evaluation of financial operations and owners’ roles is prudent. Making appropriate changes well before a sale can significantly add to the valuation.
Valuation methods
There are many valuation methods available, depending on the situation. If several comparable transactions (“comps”) exist, they can guide a valuation. If there aren’t many comps available, future revenue and profitability can be projected to determine a value based on discounted future cash flows.
Importantly, owners must realize the sale price isn’t what they’ll personally net. Many factors determine what owners receive, including taxes, the business’s ownership structure, shareholder distributions and more.
Every industry has its own buyer pool, ideal valuation method and rules of thumb. That’s why it’s vital to use advisors with the foresight and expertise to help owners find the most relevant approach, tailor it to their business and give them confidence.
Sale preparation
Selling a business isn’t easy, which is why it’s important to understand these steps and to pull together an experienced transition team comprised of professionals in the legal, accounting and valuation fields, as different experts are needed throughout the process.
The time and effort are worth it, though, once the seller realizes the fruits of his or her labor while also delivering value to the next owners.
Timing
Preparing to sell a business can take a long time — sometimes as long as five years or more. That’s because several steps are required, including:
- Making internal reforms
- Identifying potential buyers
- Marketing
- Negotiating
- Crafting a purchase agreement
- Closing the sale
As the adage goes, “Failing to plan is planning to fail.” Despite what can seem like an arduous process, the time required to plan the sale is time well spent.
