What’s it Worth?
Sooner or later, there comes the time when an entrepreneur asks the question:
“I’ve built my business and it has supported my family, but now I am thinking…What’s Next?”
Roughly half of small businesses in America are owned by entrepreneurs with ages over 55 years. In Oregon, the number is slightly higher with 56% of all businesses owned by entrepreneurs who are 55 years of age or older. What do these statistics mean?
Age pressure will force a large number of businesses to go onto the market in the next decade. Only a small percentage of businesses have a formal plan as to how they plan to transfer their business to new owners. In fact, only 20% – 30% of businesses will successfully sell once they are listed, primarily due to a lack of planning.
Many entrepreneurs report that fully 80% – 90% of their total assets are held within their businesses, with only 10% – 20% held in their private estates.
The combination of aging, lack of marketability and concentrations of wealth in assets that are hard to transfer will result in the destruction of a great many retirement plans and wipe-out a tremendous amount of legacy wealth that should be made available to entrepreneurs for retirement and estate use. With a little effort devoted to leadership, planning and systems execution, a substantial amount of potential failures can be avoided. This is an academic argument unless you are a business owner, in which case, it makes it a highly personalized risk area for you.
Oftentimes, the work involved with business succession planning and execution takes several years to perform to build a company to be able to receive a maximum valuation prior to sale. Shorting this area of business development is a leading cause of failed sales of businesses.
A second area of importance after recognizing the challenges inherent in selling a business is having a determination of what the business is worth. This is something that people will disagree on, depending on which side of a transaction a person is on – buyer or seller. Buyers have several motivations for wanting to purchase, and the motivation a buyer has can affect the amount they would be willing to pay at any given time. People being asked to provide capital to effect a transaction have limits on how much they are willing to place at risk in any transaction, so there is an implied ceiling to what the value of what business might be worth.
There are three general methods business valuators take into account when arriving at an opinion of value. No one method of valuation is exclusively used to determine the ultimate opinion, rather most opinions of value are based on a combination of factors according to the determination of how applicable each factor is. The valuators seasoned judgment is used to arrive at a final value based on percentages of each factor.
Business valuations are called opinions, as each professional who values a business for any specific reason takes into account the general conditions the company operates in, the state of the economy at the tie, the prevailing interest rates in effect at any time, and the reason for the valuation as factors that influence an evaluator’s opinion. Different people evaluate these factors among many others to conclude a determination of value for a business, which varies between professionals.
The general methods of valuing a business are:
Asset: The underlying assets owned and used by a business to create revenues and provide a tangible base for operating the business. Assets are physical and also intangible, such as intellectual property which includes ownership of processes, patents, trademarks and branding strategies.
Income: This approach to business valuation includes the revenues generated, the expenditures made to support the revenues generated, and adjustments made to filter in or out any revenues and expenses that do not directly apply to the creation of a final net income. Accounting adjustments for taxes and certain uses of surplus funds are common adjustments made.
Market: This method of business valuation is used to compare like businesses which have sold in like markets in recent times to arrive at an estimate of company value. The information in business transactions is rather thin, so this method of comparison valuation is not typically a reliable indicator of current market value in many situations for small closely-held companies. This is an excellent method for valuing publicly traded businesses on established stock exchanges.
Rule of Thumb: Some people consider a ‘rule’ that businesses within industry clusters are worth a multiple of earnings or revenues, anywhere from 1/3 revenues to 10 times net income as reliable indicators of value. This is not a method of valuation; it is more of a range indication of potential values and is rarely used by professionals when they make a determination of value. The application of any ‘rule’ for businesses in like industries typically over-values poor performers and under-values strong businesses.
For current owners, more importantly than how a business might be valued at any point in time is how a business is managed while it operates to create the products or services it offers to other businesses, government or the public. The need for a business valuation is a result, not a driver, of performance and value creation. This is an important distinction when considering how to proceed with preparing a business to be listed for sale. A perspective of understanding how business operations create lasting value is important, but the systematic building of excellence in a business’s operations over time will be reflected in increased value of the business when considering the options for transferring the business to new ownership when the time is right to do so.
Contact the Southern Oregon University SBDC and become acquainted with the team of professional advisers and mentors. The SBDC has the depth of experienced staff with business succession planning and execution to assist you with your specific needs when the time comes to evaluate your business’s state of readiness to be listed for sale.
Also, consider joining the next cohort of businesses through enrolling in the Small Business Management program offered September through May of each year, as this can help you prepare your business to be ready to sell. Contact the SBDC at:
sbdc@sou.edu https://sbdc.sou.edu/ 541.552.8300
Marshall Doak is the Director of the Southern Oregon University Small Business Development Center and a supporter of innovation and the community that forms around innovation in the economy. In private practice as owner of Managed Successions, LLC, he develops and manages projects for public and private organizations for specific goal achievement success, including advising businesses wanting to transfer ownership and retain the value created over time. He can be reached through: mdoak06@gmail.com or 541-646-4126.
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