Four Basics of Exit Planning 1: Valuation

There are four basics an owner should address before beginning any exit, succession or transition plan. They are Valuation, Distance to Goal, Prospective Buyers and Professional Team.

First, my apologies for missing a tri-weekly post. Between trips to Denver for BEI’s National Exit Planning Conference, Dallas for a client, San Antonio for our own XPX Exit Planning Summit, Nashville for the national EPI Exit Planning Summit and St. Louis for Archford’s Metro Business Owner Summit, I kind of lost track of my posting schedule.

Here is the first of the four basic requirements. I promise not to dally in posting the rest of full set.

Understanding Valuation

Value is the starting point for all transition planning. Any decision, any business plan, and every retirement projection (either for time frames or finances) must start with the value of your business today.

Knowing the value of your business is different from thinking you know it. I talk to many owners who say “I met a guy at a trade show, and he told me that he knows a guy with a business just like mine who sold his company for five million dollars. I think I’m a little bigger than he was, so I know my business is worth at least six million.”

Sounds foolish? How about “My accountant says that all small business sell for about five times earnings.” Or “Everyone in my industry knows that all companies like ours sell for one and a half times revenue.”

Any valuation estimate that is in the same sentence as “all,” or “everyone” is a crock. Multiples may serve as guidelines, but the value of a specific business is always unique to that business.

How much is a manufacturer of disposable paper products worth? How much if they specialize in paper straws? How much does that value change every time McDonalds or Southwest Airlines announces that they are switching to paper straws? How much is it worth if it is the last paper straw manufacturer in the USA (like Aardvark® Straws?) If you understand value, your mental estimate should have changed with each sentence.

Every change in the above paragraph described an intangible. Events and market conditions are as important, or in some cases more important, than last year’s numbers. Valuation starts with profitability and cash flow, but the real price that someone will pay for a business lies in the intangibles.

Intangibles

There are scores of intangible factors affecting business value. Most are related to customers, employees or systems. Ask yourself these questions (although there are many more.)

• Customers:
  • Do you get more than 20% of your sales from one customer?
  • Is your revenue recurring (by contract) or a series of one-time transactions?
  • Is your value proposition more than just “good service?”
  • Are steady or repeat customers increasing their purchases?
  • Can you forecast their purchasing accurately?
• Employees:
  • Do you have managers that can run day to day operations without you?
  • Are your key employees too close to retirement age?
  • Is turnover too high, or nonexistent?
  • Are important positions cross trained via a formal process?
  • Do you have non-competes and/or long term retention incentives?
• Systems
  • How accurate is your budgeting when compared to historical reality?
  • Are all processes documented and followed?
  • Is equipment carefully maintained?
  • Are proprietary systems and knowledge protected?
  • Do you track the effectiveness of sales and advertising expenses?

All valuations begin with profitability and cash flow. Most business appraisals take at least a cursory look at a few of the intangibles listed above. Buyers, however, will look at all of these factors and more.

Understanding the four basics of exit planning starts with valuation. If you don’t know where you are, it’s tough to plan where you are going.

For over twenty years, business owners have asked me “What can I do to increase the value of my company?” My answer is always the same.

“Exactly what you should be doing to improve it every day.”

Do you think you know the value of your business? Try the “Sellers Sanity Check,” a free tool at YourExitMap.com