Approximately 90 percent of the
businesses in the United States are
family-owned. However, studies show that two-thirds of closely held
businesses fail to survive into the second generation. Many owners spend a
lifetime building their businesses, but
several ignore the planning that is needed to transfer ownership. This failure to
adequately plan for this transition is a
leading contributor to the low survival
rate.
“A business valuation is a key first step
to help family businesses figure out
what planning steps they should take to
ensure the company survives under second generation leadership or continues
operating via the sale to key management or a third-party buyer,” says Mark
R. Schaaf, a shareholder and the director of valuation services of Briggs &
Veselka Co.
Smart Business spoke to Schaaf about
business valuations and how they can
help in succession planning and transferring ownership to the next generation.
What are the benefits of doing a valuation
for helping in succession planning?
Going through a formal valuation
process can be the cornerstone for
determining what steps owners need to
take to achieve their succession goals. It
is good to get a valuation now to get that
‘home plate’ valuation to get an idea of
what the business is worth to a third
party.
Owners of small businesses cannot
flip open the business section of their
paper or look online to see the traded
value of their company. An experienced
valuation expert knows what questions
to ask when analyzing a company to
arrive at a fair market value of the business upon which sound succession or
transition planning can be based. In
addition, the best valuators understand
the factors that create value. The valuation process can therefore frequently
reveal such valuation drivers to the
business owner in time to reposition the
company for a higher sales price at
some point in the future.
What other factors need to be considered?
Many times, the business owner has
taken the annual profits each year and
has become accustomed to a high level
of cash flow annually. Selling the business means that this annual cash flow
will go away, and then the big question
becomes: ‘What value is sufficient to
allow for a comfortable retirement or
exit from the business?’
A fair market valuation gives those
answers — often leaving the owner to
say: ‘I can work X number of years more
and get that same cash.’ Thus, frequently it takes a major life event — health
issues, family issues, etc. — to get owners to face the fact that time doesn’t go
on forever and the economic value of
the company is not dependent on some
never-ending cash flow to them. In fact,
that ongoing cash flow is what third-party buyers or subsequent owners pay
for in a purchase.
Those factors above show why it is
important to get a grasp of the current
value, as well as potential steps that
might be taken to improve the valuation
over time.
What about selling to key management?
Frequently, the value of the business is
a direct result of the efforts of a few key
employees’ efforts. A valuation consultant can walk a business owner through
the different ‘standards of value’ that
may apply to a transfer. A fair market
value would be based on the willing
buyer/willing seller concept, and this
value is often discounted for lack of
marketability issues and other issues
associated with the risk of ownership of
the business. A fair value typically is a
higher value and does not include such
discounts. A valuation consultant can
explain the differences in the two, what
it means to the owner and the key
employees, and help work out a value
and a buyout plan that is executable and
understandable to both sides.
How about transfer of ownership to family
members?
Valuations can also help in transitioning the business within the family. A
multiyear gifting plan can help accomplish this goal as well as selling to the
second-generation family members or
to trusts of the family to combine the
goal of transferring the business along
with achieving tax savings and implementing valuable estate-planning techniques.
What about selling to outsiders?
Among potential buyers for the business, independent third parties may
present the highest multiples, but there
is also the highest risk of failure and disclosure of confidential information. By
planning ahead and using the guidance
of an experienced professional, these
risks can be minimized and key selling
points emphasized.
MARK A. SCHAAF is a shareholder and the director of valuation services of Briggs & Veselka Co. Reach him at (713) 667-9147 or
[email protected].
