David Lingler, Cassady Schiller CPAs & Advisors
In the current economy, no one wants to spend money on something they don't need today. So why do you need an estimate of your company's value when you don't expect to leave for several years or have no plans of transferring any ownership?
Well, you don't need to know the value if you are certain that the value of your company is very small compared to what you will need upon sale or transfer.
Most owners, however, look to the value of their businesses as a major source of liquidity for their post-exit lives. The “intention” is to leave as soon as it is feasible rather than when you are completely burned out. Therefore, most of us need to know the value of our companies now so we can be smart about creating greater business value in as short a time as possible.
Knowing the value of your business today is critical whether you plan to leave your business tomorrow, or in many years because:
1. An estimate of value establishes your starting line and distance to the finish line.
An estimate of value tells you where your unique race to your exit begins. Your job, whether your company is worth $500,000 or $50 million, is to fill the gap between today's value (the starting line) and the value you need when you exit (the finish line). Based on today's value, your race to the finish may be shorter, longer, or perhaps much longer than you expect. Once you know how far you and your business need to travel, you can begin to create timelines and implement actions to foster growth in business value.
2. An estimate of value tests your exit objectives.
An estimate of value helps you to determine if your exit objectives are achievable. Let's assume that you decide that your finish line (financial objective) is to receive $7 million (after taxes) from the transfer of your business interest. You also want to complete your race in three years (timing objective). An estimate of value will tell you if the distance between today's value and the finish line is too great to reach in three years. If a growth rate is unrealistic for your business, you must either extend your timeline or lower your financial expectations.
3. An estimate of value provides important tax information.
First, an estimate of value gives you a basis for analyzing the tax consequences of exit path alternatives. Once you choose your path, the value estimate provides a basis for your tax-minimization efforts. Taxes can take a significant chunk out of a business sale price so the value of your company must usually exceed the amount of money you need to fund your post-exit life. The size of that excess depends on how you and your advisors design your exit, and exit design in turn begins with knowing starting value and the distance to your finish line.
4. An estimate of value gives owners a roadmap to increasing value.
When owners know how much value they need to create to meet their objectives, it helps them determine where they need to concentrate their time and effort. Instead of hoping to grow value, dedication to a goal enables many owners to exit sooner with the same amount of after-tax cash than owners who do little or no planning. Exit plan success all begins with a starting value.
5. An estimate of value provides an objective basis for incentive plans.
As you design incentive plans for key employees (such as stock purchase, stock bonus and non-qualified deferred compensation plans, long-term incentive plans, etc.) to motivate them to increase the value of your company (so you can successfully exit and provide golden handcuffs to those key employees) you must base these plans on an objective estimate of value. You and your employees need a current value (or starting line) and a methodology that you all can confidently rely on.
This is Not a Full-Blown Valuation!
Are you thinking, "How much is this going to cost me?" We are suggesting that you need an estimate of value to establish a benchmark, not the opinion of value (conclusion of value) which precedes your transfer of ownership and is used for estate and gift planning.
Estimate of Value
An estimate of value:
- Costs about half as much as a standard valuation opinion,
- Is the basis for the (later and complete) valuation, but…
- Lacks the supporting information contained in a full written opinion of value, and…
- Is used for planning only.
Failure to Value
On some level, we all recognize that we will leave our businesses someday. While you may not yet have a vision for the second half of your life, you do know that the exit from your company is likely to be the largest financial transaction of your life. Does it make sense to go into that transaction and into the second part of your life without an objective understanding of your company's value and how to maximize that value?