business valuations & business ownersas a business owner, you know that one of the rewards of...

BUSINESS VALUATIONS & BUSINESS OWNERS

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WORKING OUT YOUR FUTURE.

WHY BUSINESS VALUATION? 1

WHY NOW? 2

HOW TO USE BUSINESS VALUATIONS EFFECTIVELY & PROACTIVELY 3

WHO SHOULD PERFORM YOUR BUSINESS VALUATION? 5

HOW TO COMMUNICATE WITH YOUR VALUATION PROFESSIONAL 6

WHAT NEXT? 7

GOING FOR THE GOLD 8

Are you a business owner ready to exit the business but lacking a reliable financial plan?

Are you a business owner counting on your business value for retirement?

Do you have business partners but no current buy-sell agreement?

Are you a business owner hoping to establish a succession plan?

Is your business developing management incentives based on the value of the business?

Is your business experiencing a dispute among shareholders, partners, or family members?

Are life circumstances impacting any of these individuals?

Are you an estate and gift tax planning attorney?

If you answered “yes” to any of the above questions, then read on.

WHY BUSINESS VALUATION?

If you have a successful, operating business and are wondering “what’s next,” then the next six pages are for you.

Most private business owners have between 50% and 70% of their personal net worth tied up in their business, but they are unsure how much their business is worth. Business brokers are adept at bringing buyers and sellers together and developing a price that may make a company easier to sell. However, a business valuation professional is skilled at finding the actual value of a company and ways to improve that value (which can be done before the selling process).

To measure value improvements, an owner must first benchmark the business’ current position. Since the ultimate value of a business is how much a buyer is willing to pay for it, a good business valuation should make real-world sense. The skills of a business valuation professional can make a real difference in establishing that benchmark and determining what changes are needed to move that value upward.

Consider this analogy: If you’ve ever signed up for personal training sessions at your gym, you know that the kickoff session includes an initial assessment of current diet, workouts, weight, and body fat. The personal trainer then usually assesses and compiles that information into a baseline for creating a plan designed to achieve the highest results for you. (Of course, in the case of your business, that baseline is a valuation.) The personal trainer then applies his or her specialized knowledge to develop improvement strategies – much like a business valuation professional will do for your business and strategies.

At the most basic level, a business valuation is a professional review of a business to establish its real-world value. At its most valuable level, a business valuation is a tool for building value and providing owners with greater knowledge and flexibility. A good business valuation identifies a business’ key value drivers and anticipates what effect management decisions will have on value. Unless you are in the business equivalent of “maintenance mode” (as it’s known at the gym when status quo is your only goal), there is no more important activity than increasing value and perhaps no more important tool than a business valuation.

1BUSINESS VALUATIONS & BUSINESS OWNERS: WORKING OUT YOUR FUTURE

As a business owner, you know that one of the rewards of owning your own company is the ability to control your destiny. By providing an accurate, real-world view of where the company stands and how its value can be increased, a business valuation helps you to make better decisions in the face of changes in competition, economic conditions, and personnel. A business valuation is the management tool that makes anything possible – if used early enough and executed by owners who understand that a business is more than numbers in a ledger. The question really comes down to what you want – both out of the business and life.

WHY NOW?

First, economic pressures create the need for streamlined efficiencies designed to improve bottom lines and increase competitiveness. Beginning with an accurate picture of a business’ value is a necessary step before designing improvements. These forces increase chatter surrounding mergers, acquisitions, and potential sales – which are all decisions requiring a business valuation. Additionally, demographic anomalies outlined in books such as The $10 Trillion Dollar Opportunity explore another Baby Boomer trend – that these successful entrepreneurs are growing older without a longer-term plan. Many are just beginning to consider transitioning their businesses, if they’ve thought about it at all.

Therefore, the world of business valuation has taken on a higher profile lately. Whitepapers and books are shedding light on the mechanics of placing a value on privately owned businesses. Many discuss the differences between adjusted book value, capitalized adjusted earnings, discounted future earnings, and cash flow method. One can even easily find discussions on whether a good rule of thumb for the baseline value of a business is four, five, or six times EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).

But let’s go back to the personal trainer analogy. Discussing the mechanics of business valuation is a bit like talking about increasing fitness in that the “why” and “when” is just as important as the “how.” So the purpose of this whitepaper is to explore the “why” and “when” of business valuation rather than the “how to”; we leave that to the trainers, or in this case, the CPAs specializing in performing business valuations.

And really, shareholders should be planning their exit strategy from the very first day the business exists. If the ultimate goal is to transition ownership, then the basic function of a business is to maximize value at the time of transition. The question becomes how to do so effectively.

2 BUSINESS VALUATIONS & BUSINESS OWNERS: WORKING OUT YOUR FUTURE

HOW TO USE BUSINESS VALUATIONS EFFECTIVELY AND PROACTIVELY

Business valuations can be divided into two different camps:

1. Business valuations that “must” be done in reaction to an event like dispute, divorce, or death. All business valuation professionals have stories to tell about the calls they receive shortly after one of these unexpected events occurs.

2. Business valuations that “should be” done by proactive management searching for ways to maximize value, make better business decisions, develop succession plans, and prepare for possible future events. The best time to conduct a valuation engagement is long before a triggering event occurs – as the first step in succession planning rather than the last. And, today, more business owners are looking for ways to transition their businesses than ever before.

Consider the tale of two companies. One is a nationally known enterprise with an owner who never came to terms with the transitional needs of the business, and another is a machine shop whose owner thought he might like to sell the business.

The first business is the Miami Dolphins football team, once owned by Joe Robbie. Robbie lived to an advanced age, yet died holding 100% ownership of the Dolphins. Unfortunately, his family was forced to sell this landmark business in order to pay his estate taxes. Robbie did not make a choice between proactive and reactive; he just never acted. As a result, the family business he had built and cherished over his lifetime was lost to satisfy the IRS.

Now consider what happened when a certain machine shop owner first started to think about business valuation. After the company’s CPA estimated the value at $3 million, the owner wanted to explore his options. Working with the valuation professionals at its CPA firm, the shop’s management team began to look for ways to enhance the value of the business. Their first step was an in-depth business valuation to determine the key value drivers and provide measurable benchmarks. During this valuation, they determined how measurable changes in these value drivers would affect the value of the company. They also found problems relating to a plant manager and replaced him. With a valuation roadmap for future management and much-needed changes uncovered by the business valuation, management doubled the company’s value to $6 million in three years. In the interim, the owners discovered an added benefit: their profits increased by 50%, and they enjoyed running the business more than ever before. In the end, they decided to keep the business.

Common value drivers: Where your investment can make a differenceMost business valuation professionals will tell you that just beginning a succession plan makes a company more valuable. Why? It illustrates a first step in turning an entrepreneurial enterprise into a lasting business. That’s why business owners are often pushed by lenders and investors to start succession planning, which is meant to ensure that the business will last when the owner or key managers exit the scene.

By starting the succession planning process with a business valuation, business owners not only get a better view of how their company looks to outsiders but also the areas where they can create more value by changing the way they currently do things. Specific value drivers differ for every


business. Positive changes impact the bottom line, directly affect competitive performance, and improve employee morale and customer satisfaction. Depending on the depth of the business valuation, detailed scenarios can be developed in each of these areas. Knowing how these value drivers interact will prove invaluable to business owners looking to measure their business decisions. Here are some of the most common value drivers in any company, which – when proactively addressed – are building blocks that just may improve the company’s financial health.

• Risk levels. Identifying key risk factors and lowering them will make a company more appealing to lenders, investors, and potential partners. Although a current owner may be willing to accept certain risks in his own business, new investors/lenders are more attracted to businesses with lower risk levels.

• Growth. Larger strategic buyers are especially drawn to top line figures. But, bigger is not always better since increased sales don’t always result in increased profits. So, manage growth carefully by keeping a watchful eye on expenses incurred to generate the additional sales.

• Working capital. Cash flow is king. Managing cash flow by trimming receivables and inventory will increase value by measurable amounts.

• Margins. Do you know how much more valuable your company would be if you could increase margins by 2%, 5%, or 10%? Knowing these numbers could help you sleep better at night when considering a large investment in production equipment or personnel needed to push those margins upward.

• Workplace environment. This soft component can absolutely make a company more or less attractive, especially as it relates to management quality and effectiveness. Billionaire businessman Ted Leonsis once said, “What a lot of business people don’t realize is that there’s really only one thing they have to do … keep employees happy. We are in the happy business.” Mr. Leonsis’ comments are right on target. A company’s trained and established workforce creates a premium for the seller and buyer to negotiate.

Maintain control of the process With the baseline established by the initial business valuation and a better understanding of these key value drivers, you can measure growth in company value. Again, consider the personal


RISK LEVELS

GROWTH

WORKING CAPITAL

MARGINS

WORKPLACE ENVIRONMENT

trainer analogy. The trainer evaluates key factors impacting your overall fitness levels in an effort to help you proactively manage your health. By conducting a business valuation well before an ownership transition is imminent (or even contemplated), the business owner maintains control of the process by identifying the value drivers and developing a plan to maximize value. Waiting until events actually happen may prove to be too late.

WHO SHOULD PERFORM YOUR BUSINESS VALUATION?

The goal is to make your business as attractive as possible to a potential buyer. Business valuation professionals, while maintaining independence and objectivity, can apply their business knowledge and experience to recommend steps that will increase the value of your business. However, not all CPAs are well-positioned to perform valuations. Many are tax and accounting compliance professionals that may not possess the tools, training, certifications, and practical hands-on experience that a true business valuation specialist offers. Accredited individuals specializing in business valuation are particularly qualified and adept at knowing how to dissect a business, analyze financial statements, determine value drivers, and project future value.

Earlier, we talked about business brokers whose goal may be to set a favorable transaction price compared to business valuation professionals whose objectives include improving the value of your business. Since CPAs most often deal with the raw material that goes into a business valuation, business owners most likely will turn to them first. However, finding the right CPA who can serve as a valued business advisor may be different because business valuation is about more than numbers.

Due to the growing strategic importance of business valuation, a number of professional organizations have developed training and accreditation programs. The two most common programs include:

• ABV (Accredited in Business Valuation) by the American Institute of Certified Public Accountants.

• CVA (Certified Valuation Analyst) by the National Association of Certified Valuators and Analysts.

Just as each of us would choose a qualified personal trainer with the necessary certifications, it is a best practice to work with valuation professionals who hold one or both of these designations as they are best equipped to determine business value and provide valuable advice to the business owner.


HOW TO COMMUNICATE WITH YOUR VALUATION PROFESSIONAL

To leverage the most potential from a consultation with a valuation professional, consider these four steps.

Step 1. Let your valuator educate you.

Without question, you best understand how to run your own business. But do you know how to place an accurate value on it? Maybe not. That’s why you bring in an accredited business valuator. At the outset, he or she can explain the various standards of value. For example, most appraisals call for “fair market value,” the price at which property would change hands in a hypothetical trans-action involving informed buyers and sellers not under duress to buy or sell and with both parties having reasonable knowledge of all material facts about the business. But some assignments call for a different standard of value. A company that’s considering acquiring a competitor might be more interested in “strategic or synergistic value,” which is the value to a particular investor. Lastly, in litigated matters, a judge may disregard an expert opinion that uses an inappropriate standard of value.

Two bases of value – controlling and minority – typically apply to privately-held business interests. Valuators consider the basis of value and may apply valuation premiums or discounts depending upon the level of control the interest possesses. Additionally, valuations are valid as of a specific date and for a specific purpose. Never reuse a valuation prepared for, say, gift tax purposes, to ne-gotiate the sale of your business later – unless your valuator specifically reviews and approves it.

Bottom line: The purpose of the appraisal dictates which valuation techniques are used. For exam-ple, a divorce case might require the valuator to separately value professional and entity goodwill for equitable distribution of the marital estate. This determination may be substantially modified or ignored for gift tax purposes or for determining the sale of your business.


STEP 1

Get Educated.

STEP 2

Define Parameters.

STEP 3

Develop Objective.

STEP 4

Establish Timeline.

Step 2. Define valuation parameters.

It’s important to define the valuation parameters and other potentially required services. For instance, consider the report type. An oral presentation may suffice in some situations – such as preliminary settlement talks or merger consulting – but most assignments call for greater formality. The appropriate format is a function of client preferences, the valuation purpose, and the users of the valuation. For example, detailed written reports are usually necessary for tax-related valuations such as gifting or estate planning transactions.

In some situations, such as a business sale transaction, financial expertise beyond appraisal is needed. Also, anticipate any ancillary services (including purchase price allocation and other post-acquisition accounting issues) so that you can work with your appraiser from the outset to deter-mine which services he or she will handle.

Step 3. Develop engagement objectives and put in writing.

A valuator normally summarizes the project’s details in an engagement letter, which serves as a legal contract between the client and the appraiser. One of the main purposes of the engagement letter is to achieve an understanding between the client and the valuator. It should discuss the valuator’s duties, scope and responsibilities, and proposed appraisal costs.

Step 4. Establish a timeline.

Once you and your valuator agree on the scope of the valuation, you’ll need to schedule a time for a management interview, analysis of the business, and production of the written report. It’s often helpful to request a timeline for completing major milestones throughout the valuation process.

WHAT NEXT?

Business owners consistently work to improve their business models and processes, and business valuations are important tools in evaluating decisions. Business valuation professionals have no control over whether or not a business owner gets divorced or entangled in a shareholder lawsuit, but they do help people take care of themselves and their families by assisting them – not only during these times but when planning for the future.

Owning a business is all about freedom and responsibility. Business valuation, when performed proactively, is based on the same premises. All business owners will eventually leave their business, either on their own terms or due to life’s unexpected circumstances, such as health issues. How they handle the planning aspect determines the quality of life their family will enjoy and the future success of the business they built.


GOING FOR THE GOLD

Does your business need a business valuation, or do you have questions after learning more about them? Informative value determinations empower you to make effective management decisions by identifying the company’s strengths and opportunities for improvement. So contact CRI’s business valuation team. We’ve performed hundreds of business valuations for companies in various industries, so let us put our expertise to work for you.

Now, if only we could go to those personal training sessions for you, too!

In compliance with IRS Circular 230: Any statements or tax advice that are contained in this document are not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer.

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business valuations & business ownersas a business owner, you know that one of the rewards of...

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