Sep 20, 2022
Business Valuation and the Pursuit of an Elite Exit
One constant in business is that every business owner will eventually exit. When you’re ready to transition your business, the goal is not merely to exit, but to accomplish an “ELITE exit” where you maximize the transaction value of your business.
We think that an important action to pursue as a business owner is to make some form of regular valuation of your business, so you know where you stand and don’t leave money on the table when you sell.
“Research suggests maybe 20%-25% of business owners have done a formal valuation1, but the validity of this valuation depends on the accuracy of information,” says Mike DeWitt, CFA. He’s a Certified Exit Planner and Senior Partner at CI Brightworth. He’s also a Senior Instructor with The Business Owner Transition Academy (TBOTA), teaching exit strategies and consulting around the process to help clients achieve an elite exit.
“With private businesses, information may come from questionable sources,” says DeWitt. “Some of it is word of mouth from industry friends who sold at a particular time. Industries may trade on rule-of-thumb, such as a certain price multiple of revenues or EBITDA profit. Those metrics can help, but given different geographies and market environments, they may also be inaccurate.”
Why a valuation is important
DeWitt believes there are three common reasons to conduct a business valuation. First, knowing their financial stake in a business is valuable for most owners, at least to their personal financial planning. Their company’s value usually has a direct impact on the success of their own family and the ability to meet their financial needs down the road.
Personal financial planning is crucial and it’s valuable to answer the following three questions pertaining to business transition:
- To whom do you want to sell?
- When would you like to sell?
- At what price do you need to sell?
The last question helps drive the valuation discussion. You should know if there’s a “wealth gap” between your current personal assets combined with what your business is worth, and what you need to get from the business sale to meet your financial goals.
A second reason for business valuation is protection. It is estimated that nearly 40% of business owners don't hold enough life insurance. The owner is often the key (or a key) employee, so what happens if they suffer a disability or die prematurely? To attain adequate insurance, you must know the value of what you’re trying to insure.
A third reason is knowing how the business compares to its peers. In private markets, especially during volatile times, when considering an exit you want your business to be the most attractive one to potential buyers. Doing that and knowing how you compare will require valuation work.
Driving value higher
“At TBOTA we use all available tools to seek to increase value over time,” says DeWitt. “We like to do valuations at least annually because value changes often and may impact personal financial planning. We’ll track valuations over time and can advise clients on the particular value drivers of their business that we can improve to raise the valuation.”
As part of the assessment and valuation process, TBOTA uses the “I.M.G.O.O.D. checklist™,” which runs through a series of factors related to boosting value. These factors are:
- Increasing cash flow
- Management team institutionalizing (making management more effective)
- Growth plan and company strategy
- Optimizing financial statements
- Optimizing and documenting processes
- Diversified customer base
What type of valuation do you need?
A formal business valuation can be accurate, but also expensive and time-consuming. It involves income-based approaches like discounted cash flow, or a market approach using metrics like comparable sales. TBOTA has invested in a software company with a patented system that TBOTA believes provides a reasonably accurate value assessment, but at a fraction of the time and cost of a formal valuation.
If you’re in an imminent sale situation, you’ll want a formal valuation because the buyer likely needs that. As an annual assessment, however, the software TBOTA employs can arrive at a valuation using data from millions of real-time transactions in specific geographies and industries.
DeWitt states the TBOTA process results in a detailed report of roughly 25 pages where many of the inputs come from the I.M.G.O.O.D. checklist™. The report uses metrics like asset, enterprise and liquidation value to calculate valuations, as well as a range of specific KPIs tracked over time so you can review business performance on an absolute basis and relative to industry benchmarks.
Says DeWitt: “I’d like to reiterate the importance, as you’re busy with day-to-day business operations, of strategic planning and conducting a periodic valuation assessment using software like ours that produces a robust report. If you drive your business valuation consistently higher, you may achieve an elite exit when the time comes.”
