The Business Divorce Law Report
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Understanding the valuation of the business is critical to the owners of closely held business in planning and management.
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Closely held business owners typically have most of their personal wealth tied up in their company, but rarely know the current value of the enterprise.
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Current valuation data is important for strategic planning, dispute avoidance, insurance purchases and tax compliance.
Understanding the value of your business is critical to the management and operation of a business, to protecting the value of the business, and to planning for the future. Many owners see valuation as an issue that you need to look at at certain stages in the life of the business—wwhen someone dies or gets divorced, when it’s sold, or when there’s a tax issue.
That value, however, doesn’t consider other, crucial reasons why valuation is necessary for the business owner. The reasons are both defensive and offensive. For example, you cannot know how much insurance you need for your business if you’re just guessing about what it’s worth. You need this information for the defensive purpose of protecting your investment.
Offensively, business valuation is a strategic tool that offers insight, guides decisions, and uncovers opportunities for growth.
Business owners, on average, have about 80 percent of their personal assets tied up in their businesses. But four in ten owners of closely held businesses have never had a formal valuation of their business done. Many more owners do not have a clear picture of what the business is worth today.
Summary
Business valuation is a multi-faceted tool essential for strategic planning, investment analysis, legal compliance, and more. It gives owners a deeper understanding of their company’s financial health, is an important step to optimize operations, and will help to put the business in perspective by looking at its performance among its peer group.
I am a lawyer, a certified valuation analyst, and a certified exit and succession planner. I have worked with the owners of closely held businesses throughout my career.
Contact me if you have questions about valuing your business, developing an exit plan, or implementing the legal bulletproofing necessary to protect your investment.
Companies are often bought and sold based on a multiple of their pre-tax earnings, known as EBITDA, which is an acronym for “earnings before interest, taxes, depreciation, and amortization.” Companies trade in a range based on factors like profit margins, customer risk , industry trends, and growth potential. These are key elements in driving a successful business. For example, a particular type of company might trade for 2.5 to 7 times its EBITDA. Being “best in class” means a higher multiple and more value in the business.
Businesses can be valued using a number of criteria. The market, however, tends to look at the value of a business as a function of its pre-tax earnings.
1. Strategic Planning
Understanding your business’s foundation
Valuing your business provides a snapshot of its current standing, serving as a foundation for strategic planning. This knowledge allows you to identify strengths to build upon and weaknesses to address, ensuring that your business strategies are informed and effective.
By understanding your business’s value in relation to its earnings, you can make informed decisions about strategic planning and operations. This perspective allows you to assess where your business stands among its competitors and make adjustments as needed to improve performance.
2. Raising capital
Communicating value to investors
When seeking investment, the value of your business is paramount. Understanding your current valuation demonstrates to potential investors the worth of your enterprise, supports your negotiations, and helps secure the funding needed for growth.
Saavy investors want to know that there is real value in the business that they are considering for investment and will expect to have access to current reports and data before committing capital.
3. Preparing for a Sale or Merger
Maximizing Your Return
Whether you’re considering selling your business or merging with another company, understanding its value is crucial. A valuation ensures you’re well-informed during negotiations, helping you maximize the return on your life’s work.
Here again, transaction partners, including the other side in a merger or sale, expect data and transparency and will typically conduct their own valuation before concluding any deal. It’s important to be well-informed and have a clear idea of what the business is worth.
4. Succession Planning
Securing the future
For family-owned businesses or partnerships, succession planning is vital. Valuing your business accurately is a critical first step. Preparing a business for sale will often require several years of planning and improvement in core operations.
The Exit Planning Institute advises the owners of closely held businesses on strategies to lower risk, improve stability, and maximize pre-tax earnings. This technique, called value acceleration, can provide logarithmic growth in value over a relatively short-term period.
A family-owned manufacturing company, for example, may need to evaluate their current operations and invest in technology to streamline production processes in order to increase profitability and attract potential buyers.
By implementing value acceleration strategies, such as implementing lean manufacturing practices and developing a strong management team, the business can significantly increase its market value and ensure a smooth transition of ownership when the time comes for succession planning.
Understanding where the business stands presently and where it could go in terms of value is the first step in developing a viable and effective succession plan.
5. Tax Planning and Compliance
Mitigating tax burdens
Valuing your business is essential for accurate tax reporting and planning. It helps in determining tax liabilities for estate taxes, gift taxes, and other tax-related matters, ensuring compliance and potentially reducing tax burdens.
Implementing tax planning strategies allow owners to mitigate tax burdens and maximizing tax efficiencies. Understanding the value of the business allows owners and stakeholders to make informed decisions that minimize tax liabilities and ensure compliance with tax regulations.
By implementing tax planning strategies based on the business’s value, owners can take advantage of deductions and credits to reduce their overall tax burden.
This proactive approach not only protects the business from unnecessary tax burdens but also sets the stage for a smooth transition in ownership and succession planning.
6. Litigation Support
Protecting your interests
In legal disputes, such as divorce proceedings or business partner conflicts, a business valuation is often required. It serves as an objective measure of the business’s worth, aiding in the resolution of disputes and the protection of your interests.
7. Business Expansion and Acquisitions
Guiding Growth Strategies
For businesses looking to expand or acquire others, valuation is a guiding light. It helps determine the viability of expansion plans, assess the worth of potential acquisitions, and ensure that investments are made judiciously.
Knowing where your business stands in relation to its peers is a key way that business owners can identify the areas where they will want to focus their efforts. Understanding what the metrics are for the best-in-class competitors helps guide the decisions that owners need to make today and in the future.
By understanding the valuation of your business compared to others in the industry, you can make informed decisions about where to allocate resources and how to strategically grow your company.
Additionally, knowing the value of potential acquisitions can help you negotiate better deals and ensure that you are investing in opportunities that will provide a strong return on investment. Overall, using valuation as a tool for guiding growth strategies can lead to more successful and sustainable expansion efforts..
Conclusion
Valuing your business is a strategic imperative that transcends mere numbers. It provides a clear picture of where your business stands today and outlines a roadmap for where it can go tomorrow. Whether you’re planning for growth, preparing for sale, or simply aiming to understand your business better, a comprehensive valuation is indispensable.
Embrace the journey of understanding your business’s value. It’s not just about arriving at a figure; it’s about unlocking potential, making informed decisions, and paving the way for future success.