There comes a time in the life of almost every successful business owner when thoughts turn to ending their involvement with the business. For some, that means succession planning; for others, it means crafting an exit strategy.
In either case, it’s important to start with a sound business evaluation, according to Royce Stutzman, a business valuation expert and chairman of Vicenti, Lloyd & Stutzman LLP. “It’s important in terms of realizing the most value for a business when it comes time to sell.”
Smart Business talked with Stutzman, a certified valuation analyst, about the role of valuations in planning a succession or an exit from a business.
Why is business valuation an important aspect of the planning process?
You have to start somewhere. In the context of selling the business, I think starting with a valuation allows the owner to begin to understand how the market will look at them. It’s very much like getting ready to sell your house. You freshen it up so that it looks appealing to the buyer and gets more value. It’s the same way for a business. When you are getting ready to sell, you need to know what the market will look like, what will appeal to a prospective buyer.
Unfortunately, it takes more time in most instances to freshen up a business than to freshen up a house. I think in terms of getting two to three years lead time for an owner to get their house in order so they present themselves well. That way, a prospective buyer will find a company that they can step into and go with it.
Do most business owners have a realistic sense of the value of their businesses?
Many times owners, especially those that have started their business, will think it’s worth more than what the market thinks. Starting with an initial valuation helps the owner prepare himself or herself for the realities that are out there. Sometimes it goes the other way, too. They may think their business is not worth much when, in reality, it’s worth more than what they think. So you start with a valuation and get the owner in a reality mode, and then you go to market with it.
What are the key issues in determining a business valuation?
It depends on the business. Most times it’s the cash flow that’s generated by the business. If you have a very profitable business that’s in an industry that’s above the margins that most businesses realize, it’s going to demand a premium.
Sometimes it’s geographic location because somebody wants to enter a specific market. Sometimes it’s sales and the expectation of driving cash flow in the future. But more times than not, it’s profitability, it’s cash flow.
What are some common techniques for exiting from a business?
One of the techniques that is used is an employee stock ownership plan (ESOP). In a successful company that shows a consistency of profits, you can often structure a very nice strategy for the sale of a company to the employees. It’s a very good strategy that, in the right circumstance, can be beneficial for everyone involved. We see that with some regularity.
We also see in family companies a succession plan, along with an exit plan, where there are children in the company who are capable of running it so there is a plan to move the ownership to the second or third generation of the family.
With that technique, you will frequently see a gift or a combination of a gift and sale. And you have to have a valuation in order to do it so that it doesn’t create tax problems.
Another technique that we see is a sale to a key employee or two who will take out the owner. That’s another plan that would be a succession plan and exit for the owner.
How do strategies or techniques differ when planning a transfer to family members?
When a family is involved, I think in terms of what I call succession capital. There are two sides of it. There’s the side that the parents need to have in capital to take care of themselves and feel comfortable with having financial independence.
Many times, there is a lot more on the table than what they need to have, so when I am working with families like this, I try to separate how much you need to have and how much do you want to pass on to the second or third generation. You want to transfer that succession capital at the least tax cost you possibly can. There are techniques to do that by not giving control, for example.
How can a business owner better prepare for this process?
An exit strategy or succession plan ought to be done three to five years in advance of the time the person expects and wants to be out of the business. There are a lot of things that can be done to prepare. Mostly, it’s the individual being emotionally ready to do the kinds of things that need to be done to pass the business on.
Royce Stutzman is chairman of Vicenti, Lloyd & Stutzman and heads business valuation and litigation support services. He’s a Certified Valuation Analyst and a CPA. He is a frequent speaker on valuation and litigation subjects. Reach him at (626) 857-7300 or [email protected].