Valuation as an Important First Step in Succession Planning

By Jeff Faust, CVA, Director of Valuation Services
ASL Business Valuation Services 

As business owners approach the age of retirement, it is essential to understand the value of their business in order to plan for their exit. Will you simply close the doors, sell to a third party, gift to another family member, sell to another family member or sell to your (key) employees? In any case, knowing what you may receive for your business will help decide the route you want to go.

Although having sufficient assets outside the business seemingly diminishes the need for a valuation, there may be advantages to gifting the business (either to another family member or a key person) rather than merely closing the doors. A valuation will allow for planning around a gifting strategy. (And it will be needed to support the gift for tax purposes.)

Questions to consider:

  • Is the business a substantial asset to the owner? If yes, the gifting of the business may not be economically feasible and the owner will need to receive some compensation for the business, either from closing it or selling it.
  • Is there value to just closing the business? Closing the doors may mean the owner can pull out the remaining cash, collect the receivables, pay the liabilities and still have something left over. While this won’t be the preferred exit for your employees, there may be value in this option.
  • If merely closing the doors isn’t an option, is there even transferrable value? In some situations, there is not a lot of transferrable value (businesses that are extremely dependent on the owners) and sometimes the entire business is transferrable (when the business is not dependent on the owners, either for sales or operational aspects). Understanding whether or not there is transferrable value will be critical to determining which path to take and how much you can get for your business.

The valuation process includes an analysis of the business under the current structure and determines its worth. The methods used will include income, market and asset approaches:

  • Income approaches look at the cash flow that the business generates and determines the value based on that cash flow or earnings potential.
  • Market approaches look at transactions that are taking place in your industry/market and what others are paying for those businesses.
  • Asset approaches look at the liquidation value of the business and are generally not used to value a business for sale (but may help in the “sell it” or “close it” decision).

The valuation process is a four to five week process and includes a “fact-finding” component; a detailed discussion on all aspects of the business, the dependence on the owners and the key risk areas, or lack thereof. Sometimes, all the various methods converge (closely grouped) and sometimes they do not. In either case, this can help in understanding what drives the value of the business and the best route to take.

There are many choices an owner has in transitioning out of their business. Planning ahead with a valuation will allow the owner to make decisions now to position the business for an exit and maximize the value received at the point of exit.