Continuing from our last post, Successful Business Exits are Not Natural, let’s look at the final three questions that business owners need to answer (and Exit Planning Advisors need answered) on their way to a successful exit.
Question 4. What is your business worth?
“The current value of my company is $________.”
Common Assumptions: Most owners base their estimates of their businesses’ value on prices they’ve heard quoted for similar businesses. Additionally, many owners tend to overvalue their businesses, which prevents them from growing value and often leads to a rocky exit at best. Building business value often takes years, so it’s important for owners to understand what their businesses are worth currently to avoid any surprises when they are ready to exit.
All We Want Are the Facts: Owners must base their estimates of business value on the estimate of a well-experienced valuation expert. While estimates don’t quite rise to the level of fact, they are far more reliable than owners’ guesses, which are often based on what they have heard about valuation multiples in their industries.
In the initial stages of planning your clients’ exits, you don’t need to provide a full opinion of value. Instead, your Advisor Team’s business appraiser should provide a “calculation of value” for Exit Planning purposes. These cost a fraction of a full opinion of value, which your clients will need when they actually transfer ownership.
Sources of Accurate Information: There are two sources of information to use, based on whom your client transfers the business to.
- If your client plans to sell to a third party, your Advisor Team’s investment banker or business broker will be able to help. Investment bankers and business brokers will typically provide owners with a range of likely sale prices. Investment bankers normally do not charge for providing a range because they want the owner’s business and hope to represent the owner in the future. Business brokers often do charge to provide this service, although at a relatively low cost.
- If your client plans to transfer the business to children, management, or co-owners, your Advisor Team’s experienced business appraiser will be the best source of information.
Question 5. At what rate do you expect your cash flow and business value to grow?
“I predict that the value of my business will grow at the rate of _______% per year beginning this year. I predict cash flow will increase during the same period by ________% per year.”
Common Assumptions: Business owners tend to be far, far too optimistic about projecting future growth. While this optimism is the driving force behind starting a business, it can cut owners’ efforts to exit at the knees. So, owners need to ask, “Does my estimate of business growth exceed its historical rate? Do the facts support my estimate?” It’s likely that many owners’ initial estimates will be well off.
All We Want Are the Facts: Your clients should base their estimates of future growth on actual past growth rates and amounts. If an owner projects future growth that exceeds historical growth, that owner must document why cash flow, revenues, and profitability will exceed historical patterns and by how much.
Sources of Accurate Information: Your Advisor Team’s CPA or business consultant should advise your clients in projecting future growth. Additionally, owners should monitor and adjust the CPA or business consultant’s projections over time. An essential part of most Exit Plans is the development and refinement of written growth plans. Current plans and, most importantly, future growth plans are modified based on actual experience.
Question 6. What will the net proceeds be from the sale of your business?
“The net, after-tax amount I expect from the sale of my company at closing is $________.”
Common Assumptions: In calculating how much they’ll receive from sale proceeds, most owners simply deduct capital-gains taxes from the sale price they expect. However, this is not enough. They also need to deduct the costs of sale, repayment of company debt, perhaps ordinary income-tax consequences on the sale of assets, and a likely owner carryback or earn-out of a significant part of the purchase price.
All We Want Are the Facts: In addition to capital-gains taxes, there are several reductions to the proceeds owners receive at closing: business debt, selling costs, owner promissory notes carrybacks, earn-outs, and the like.
Sources of Accurate Information: Knowledgeable professionals (such as your Advisor Team’s CPA, M&A advisors, or transaction attorney) can provide guidance on your clients’ likely deductions from sale proceeds for a relatively low cost (hundreds of dollars, not thousands).
As you review your clients’ answers to these six questions, note how many them are fact-based. For answers that are not based on facts (and if your clients can’t point to a statistic or study to support their answers, chances are those answers are not fact-based), you and your Advisor Team will need to professionally explain the pitfalls of assumption-based planning. Achieving the post-business life that your clients desire is simply too important to rely on hope and assumptions, but with you and your Advisor Team on their side, your clients have the best chance to base their decisions on facts.
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