What’s your business worth?

ther you're passing on the company to a family member or selling to outside interests, you will require a business valuation that establishes a realistic and fair price. This value will be an important focal point of your transition plan.

Valuating a business is not a simple task. The number you have in mind may differ from that of your family successors, potential buyers or tax assessors. It's probably best to call in a specialist who can look at your assets, liabilities and goodwill with clear-eyed detachment.

Different methods can be used to arrive at your business valuation, and they can be used alone or in combination.

Asset-based approach
This method totals up all investments made in the business to date. It does not account for the depreciation in the value of machinery that may be several years old, or other assets that have declined in value.

Business comparison
This approach determines a company’s market value by comparing it to similar companies in the field and transactions that have occurred in the recent past. For a highly specialized business, it may be difficult to research comparable transactions.

Company's past earnings
This method calculates a company’s value by its past earnings and profits. Those earnings and profits, however, are not a guarantee of future growth.

Doing it yourselfIf you are intent on determining the market value of your company yourself, here are some pointers. First, determine just what it is that will be sold — or passed on — to your successor(s) or buyer(s).

• Do you have significant physical assets, or are you selling goodwill and client lists? How valuable is that client list, and does it include quality clients? Can you charge a premium for your client list, business name or logo?
• If you have equipment, how much equity do you have in it? If it's not leased, consider asking a machinery dealer for an appraisal.
• How about receivables? What state are they in? What percent are at 60, 90 or more days?

Once the assets have been added up, look at your liabilities. These include all outstanding company debts, of course, as well as variables such as unresolved lawsuits.

Some industry groups publish business valuation data based on sales and net cash flow. This data can be used to estimate the value of your business. Research firms that are similar to your own to see how much they sold for. Your company, however, may be a model of efficiency and profitability that outstrips all the rest, so those numbers are not necessarily the best basis of valuation.

Getting professional help
Business valuation requires some legwork and a lot of research. Do you have the time, the proper tools and the inclination to do it? If not, you might consider using a business valuator, who may be an accountant or a lawyer and should be experienced enough to determine the best method or combination of methods for the task at hand.

Your present lawyer or accountant may be able to recommend someone. Be sure to ask for references of similar business valuations that he or she has done.

Improving that number
Whether you’ve done the valuation yourself or had it done by a professional, once you've arrived at a realistic number, it's only reasonable to wonder how that number can be improved. BDC Consulting has the resources to provide you with transition planning and business coaching solutions to make your company more valuable.

• One way of enhancing value is to increase sales — the "top line" — and reduce expenses such as owner perks to improve the "bottom line."
• Do you have variable liabilities such as outstanding lawsuits? If so, these should be settled before you begin the transition process.
• If you are the business — that is, if you are closely identified with the company — consider giving more responsibility to employees. They can make the transition to ownership and thereby render your company more valuable.
• Finally, your business may be more valuable in pieces than as a whole. A buyer may find your real estate holdings more attractive as an asset than as part of a potentially risky business.

There are many ways to estimate and enhance the value of your company prior to your business succession, and it pays to do your research and find a qualified business valuator. A professionally derived valuation will contribute to a smooth transition and continued harmony among family members.

Transition planning: What you need to know

Everyone who operates a company will eventually reach a point when they will have to leave the business because of age or health concerns. This could mean retirement, sale or simply winding up the firm and closing it down.

Collectively these are known as exit strategies, and every business owner should have one. Yet many will exit their companies without a clear plan. This may be largely due to the fact that entrepreneurs are more focused on starting and building their businesses than on leaving them.

The result? When business owners are ready to pass the torch, they may not get the full value of their company if they're selling to outside interests. Or if it's a family transfer, they could end up leaving family members with unmanageable problems instead of the inheritance they had hoped to bestow.

You can always make better business decisions by planning ahead. If you start to think about succession planning early, you can take a more objective look at your future needs and avoid last-minute decisions. Although unique to every business, a succession plan consists of a series of basic steps, such as setting your financial goals, determining legal requirements and establishing your objectives with your family or successor. It is often a complex and sometimes emotional process for a business owner.

"One of the most important steps is first knowing all the options available to you for exiting," says Calvin Hughes, a BDC consultant. "It's important that you feel active and engaged in the process. But at the same time, you have to accept that you're letting go of your business."
Here are some of the most common exit strategies used today.

Family transfer
If transferring your business to a family member is a possibility, it's key to ensure that your family is fully aware that you're planning a succession and to give them clear time parameters. A part of this, says Hughes, is ensuring that family members get a chance to voice their concerns and interest in the business. One of the most obvious advantages of opting for a family transfer as an exit strategy is that your family will benefit from your business legacy. As well, family members who are already involved in your business may require less coaching or involvement.

Management buyout (MBO)
The purchase of a company by its management team has several advantages for entrepreneurs. It can ensure uninterrupted continuity because the new owners already have invaluable experience with the company. For this reason, your company is more likely to keep its existing clients and business partners.

Selling to outside interests
Selling a business to outside interests is the most popular exit strategy because it's typically "more definitive and involves fewer variables than a family succession," says Hughes. Entrepreneurs should appreciate that the price they receive for their company might be more or less than the appraised market value. "While many business owners tend to overestimate the pricing of their businesses, a surprising number may underestimate it. For example, if your company becomes part of a much larger venture, then the value may go up accordingly," he says. A large corporation that is buying out a business, for instance, may be able to do more than you have with your business and therefore willing to pay a higher price.

Getting the full value for your business
Whether you're passing the company to a family member or selling it to outside interests, keep in mind that you will need a business valuation that establishes a realistic and fair dollar figure for your business. "Putting that dollar value on a business takes time, and you need to have a specialist who can look at your assets, liabilities and goodwill with an objective viewpoint," says Hughes, adding that he has seen too many cases of entrepreneurs who got caught at the last minute and weren't able to get the full value they had envisioned.

For entrepreneurs who choose selling as an exit strategy, Hughes feels they should also be aware that buyers are increasingly more sophisticated and demonstrate more business savvy. "Smart buyers will certainly delve more into your business history. So in turn, you have to anticipate this and be sure that you're armed with the right figures and backup material to get the value that you're looking for. You don't want to find yourself in a vulnerable position," he stresses. Company owners should keep in mind that the value of a business is not just based on financial statements. "The number of customers you have, for example, could also be a determining factor," he says.

Planning ahead
"Planning ahead, at least 18 months to 2 years, helps entrepreneurs make better business decisions," he adds. The earlier you start, he believes, the more time you can take an objective look at your company and where it will be down the road. Succession planning takes time, Hughes stresses, because of many complex issues such as business valuations, tax implications, family matters and coaching successors.

One of the first steps in good planning is to get a lawyer involved at least 12 months in advance. Getting legal help as early as possible in the process can help you avoid frustrations down the road such as delays, extra expenses and ultimately a deal that doesn't meet your expectations.

A common exit strategy: The MBO ...

If you're an owner looking to sell your business or an employee thinking of buying the company you work for, you should be familiar with the term management buyout (MBO). In its simplest form, an MBO involves the management team pooling resources to acquire all or part of the business they manage. A Leveraged Management Buyout (LMBO) is similar to a MBO, except that the buyers use company assets as collateral to secure financing.

Most of the time, the management team takes full control and ownership, using their expertise to grow the business. An MBO/LMBO acquisition, which can be sizable, is usually funded by a mix of personal investors, external financiers and the seller.

For a business undergoing a change in ownership, the MBO/LMBO offers advantages to all concerned. Most obviously, it allows for a smooth transition. Since the new owners know the company and its business, there is reduced risk, other employees are less likely to be apprehensive and existing clients and business partners are reassured. Furthermore the internal process and transfer of responsibilities remain confidential and are often handled quickly. Once a business owner has agreed to sell his company to members of his staff, there are usually a series of common steps in the transfer of power:

• Buyer and seller agree on a sale price.
• A valuation of the business confirms the agreed-upon price.
• Managers assess the portion of the shares they could purchase immediately, and then draft the shareholder agreement.
• Financial institutions are approached.
• A transition plan is developed that incorporates tax and succession planning.
• Managers buy out the sellers' interest with financial support.
• Decision-making and ownership powers are transferred to the successors; this can take place gradually over a period of a few months or even a few years.
• Managers pay back the financial institution. This is done at a time and pace that will not unduly slow the growth of the business.

Buyers will need to ensure that the venture is profitable or at least has good potential to be. Keep in mind that the MBO/LMBO requires substantial financing, which will have an impact on company cash flow. To compensate for the repayment, the buyer will need a strategy to increase cash flow through cost-cutting, improved productivity or building revenue.

A thorough financial analysis should reveal cash flow, sales volume, debt capacity and potential for growth. This will provide valuable information on the fair market value of the business and on management's operating flexibility.

How to finance an MBO/LMBO
The buyer(s) will need to develop a strong business plan to prepare for the acquisition. The forecast should be credible and realistically attainable. Personal and business contacts and referrals can also help a successor secure confidence from bankers. A small buyout usually involves only one institution. In larger transactions, several institutions may handle the financing.
In an LMBO, business assets are evaluated to determine the equity available for financing. The lender will use the assets as collateral. The financial institution will adjust interest rates according to the risks associated with the transaction.

The financer may ask the seller to finance a portion of the sale as a form of commitment to the venture, and as a sign of confidence in the management team. Be sure to shop around for the best terms.

Any of these types of basic financing may be combined to achieve a successful transition.
Personal funds can help secure confidence from a financial institution, add equity to the transaction and share risk. Buyers often need to invest a significant amount of personal money — which may involve refinancing personal assets — to demonstrate their commitment. Loan or credit notes from banks are often used to purchase owner shares in the business. This type of financing is attractive because of its simplicity—assets are used as collateral—and because interest rates are lower.
Seller/owner financing can extend payments over a number of years. This form of financing is tied directly to the seller and may include credit notes, loans or preferred shares. This may reduce cash outflow at time of transaction and make the transition easier.

Similarly, an installment purchase of stock allows the seller to maintain a level of control until he or she is completely paid off.

Selling stock to employees can be used in conjunction with an MBO/LMBO to finance the remaining portion. The Employee Share Ownership Plan Association explains how this type of financing enables other employees to purchase stock options in the business. This can give incentive to existing employees while the management team retains control of the business.

Subordinate financing can complement a management team's equity investment by bringing together some features of debt financing and equity financing without diluting ownership. If a profitable business maximizes the financing on its assets, and the management team's personal funds are insufficient, then subordinate financing may take on a higher risk to participate in the venture. Repayment terms are established at time of transaction.

For more information: http://www.bdc.ca/EN/advice_centre/sell_your_business/Pages/RelatedArticles.aspx?PATH=/EN/advice_centre/articles/Pages/succession_mbo.aspx