Why is Business Valuation So Critical for Succession Planning?
As a business owner, you’ve invested more than money into your business. Your success is the result of years of hard work and planning that has enabled your business to grow and thrive. However, at some point, you will consider moving on from ownership and passing your company along to new owners. This succession could involve family members, current employees, or third parties who are interested in continuing the legacy you’ve created.
When it is time to think about succession planning, how do you ensure you receive fair compensation for your business? Understanding the valuation process and the various methods of determining value can be vital. While you may have a sense of the worth of your operation, it is very common to over- or under-estimate the value of your business due to your emotional connections to the company or your successors.
Enlisting the assistance of an outside appraiser who can implement the types of valuations that best suit your specific business can be invaluable to making sure you maximize your business’s value. A Minnesota business succession planning lawyer from Metropolitan Law Group, PA can help you with business valuation and other essential aspects of transferring your business to a new owner.
What Factors Can Influence a Business’s Value?
The first step to creating a succession plan is understanding what your business is worth and what you need to receive to make a transition worthwhile to you. Every business has tangible and intangible assets that contribute to its value to a potential buyer. The obvious tangible assets, such as equipment, supplies, and commercial property, are relatively easy to calculate.
However, much of the value of your business lies in more complex factors, including:
- Intellectual property: Your business’s unique methods, trade secrets, patents, copyrights, reputation, and other intangibles account for a large portion of the worth and appeal to a prospective buyer.
- Growth and earnings potential: If your business is in a location or industry poised for growth or expansion, it can significantly increase its value.
- Industry risks: Certain types of companies face more market volatility than others, and the risks a new owner would be taking on should be factored into any valuation.
- State of the economy: While some types of businesses will always be in demand, most are subject to ebbs and flows in the economy. If there is an economic downturn or a large boom in your industry, the value of your business could be impacted.
- Anticipated cash flow: If your business has demonstrated the ability to consistently create higher-than-average earnings, this trend of reliable cash flow could result in a higher valuation.
- Personal goodwill: Many businesses, especially smaller operations, owe a large part of their success to the charisma, skills, and reputation of their owner. Because any new owner must rebuild this personal goodwill following a transition, it could reduce the business’s value.
What Methods Can Be Used to Determine the Value of a Business?
It is essential to know what your business is worth and what factors can impact its value, whether an ownership transition is imminent or you are simply in the beginning stages of succession planning. With a proper valuation, you can protect and improve your business’s worth, make an informed decision on purchase offers, or work towards a retirement plan.
There are a number of ways to create an accurate valuation that can assist you with your future plans. The best calculation(s) for your business will depend on your unique circumstances. A business valuation lawyer can help you determine which technique is right for you.
Some standard methods include the following:
- Book value: This is an asset valuation of your entire business minus its liabilities, with the assumption that the company will continue operating as usual. Essentially, this calculation determines how much it would cost to recreate your whole business if you had to start from scratch.
- Liquidation value: Accounts for the material cost of all tangible assets if they were sold and all debts paid off. The result is generally lower than the book value because it does not consider the value of these assets as part of an ongoing business operation.
- Cash flow valuation: A common method used for businesses with shareholders, a cash flow valuation calculates the income a business is currently bringing in and extrapolates it into the future.
- Multiples of earnings: If your business has stocks, you can use this calculation to determine your company’s capability of creating future earnings for its shareholders to generate a valuation.
- Market valuation: Similar to assessing your home’s value by looking at comparable homes that have sold recently in your area, you may get an idea of your business’s value by studying the recent purchase prices of competing companies. However, this method is only useful if several similar businesses have been on the market recently.
Why Consult With a Business Valuation Lawyer?
Succession planning can be a challenging topic for many business owners. You may feel like you don’t have time to focus on something that far in the future, or it may make you uncomfortable to think about relinquishing control over a business you’ve worked so hard to build. However, by starting your succession planning early, you can create a strategy that allows for a smooth transition.
No matter the size of your business, Metropolitan Law Group, PA, can provide the knowledge and legal guidance you need to build a strong succession plan. To book your business succession strategy session, contact our law firm at 612-448-9653 today.