Step Two: Establishing Business Value and Cash Flow

Step One establishes what you want (or need) in order to leave your business in style. Step Two determines what you have — how much is your business worth? If you're selling to a family member, key employee or co-owner, future cash flow (for reasons you will learn) of the business after you leave it, is even more important than value. Step Two is a critical step in the Exit Planning Process. It cannot be ignored nor can it be skipped while you go on to other parts of the process. You must value your business and you must do it at the inception of the Exit Planning Process. The reason for emphasizing valuation at the outset is simple.

The fundamental Exit Objective questions are:

• When can you leave the business?
• How much money do you want or need?
• Who can you transfer the business to and how can you get paid what you need?

Each Exit Objective question can only be answered in light of "how much money can I expect upon leaving the business?" This interplay between establishing Exit Objectives and obtaining a business valuation is not static. Selling your business to an outside third party for cash is a very different Exit Objective than is selling or transferring your business to a family member, employee or co-owner (an "insider"). The reason is simple. An outside third party has cash, the insider does not. The valuation approaches used for inside vs. an outside sale are dramatically different.

The valuation approach for a third party sale is to value the company at three points during the Sale Process:

• A preliminary (or "ballpark") estimate of what the business is worth. This is used to help owners decide if the business can potentially be sold for sufficient cash to meet their exit criteria.
• A formal valuation. This in-depth valuation documents and confirms (or adjusts) the original ballpark estimate. This is a critical undertaking that should be completed before you begin the actual Sale Process. This valuation should normally be performed by the business broker, investment banker (or other transaction advisor) who conducts the sale of your business.
• A marketability and pricing analysis. This analysis is performed during both the preliminary and formal valuations and again as the business goes to market. It must be performed by your transaction advisor: 1) to gauge existing market conditions; 2) to assess what the market will likely pay; and 3) to determine if now is the best time to market your particular business.

At each of these valuation points, the owner seeks to obtain the highest possible valuation. This valuation process is described in detail in the soon-to-be-released new book by John Brown, Cash Out Move On: Get Top Dollar — And More — Selling Your Business.

On the other hand, an owner seeking a valuation because he or she wants to gift ownership to children or sell stock to employees will, for tax reasons, seek the lowest defensible value for his or her ownership interest. Those performing the valuation usually use historical information to establish an "as-is" valuation. Often a CPA or valuation appraisal firm is the most appropriate choice for performing a valuation.

Owners who wish to transfer their companies to insiders (children or employees) must craft a plan to reap their sale proceeds in a tax-sensitive manner. Remember, in a transfer of this kind, the buyer must look to the future cash flow of the business to pay the departing owner. Consequently, the tax consequences to the buyer as he/she pays for the business are critical. Too high of a business value means that the tax consequences — to the buyer —may prevent the buyer from acquiring the business. Techniques exist to minimize this tax impact while likely still providing you, the owner, with 100% of the cash you would have received from a sale to a third party for full market value.

To learn more about this not-so-obvious, yet critical, aspect of transfers to insiders, please see Step Five. You might also read Chapter Two, "Making a Molehill Out of a Mountain" in our book, "The Completely Revised How To Run Your Business So You Can Leave It In Style,"

This brief overview of valuation illustrates how Step Two is influenced by, and in turn influences, the rest of the planning process.

Resources

Library

The Transferring your Company to Key Employees White Paper - Owners wishing to sell their businesses to management (key employees) face one unpleasant fact: their employees have no money. Nor can they borrow any-at least not in sufficient quantity to cash out the owner. The transfer methods described in this White Paper employ a long-term installment buyout of the owner or use someone else's money to affect the buyout. "Cash Out Move On: Get Top Dollar — And More — Selling Your Business" "The Completely Revised How to Run Your Business So You Can Leave It in Style" (Chapter Two: Making a Molehill Out of Mountain). The Exit Planning Review™ eNewsletter You can request these materials by contacting BEI.

Team

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The Bottom Line

If you wish to sell your business to an outside party, a professional valuation of your company is essential at the inception of the Exit Planning Process. It is critical in the development of an accurate and comprehensive Exit Plan. We have affiliates who can perform a business valuation at the outset of the Exit Planning Process to determine what the business is worth (based upon recent market activity in your industry) in today's Merger and Acquisition marketplace. This valuation also includes a determination of your company's marketability. This approach differs significantly from standard valuations based on historical information because it gives you the information you need: your company's market price and its marketability. This approach differs significantly from standard valuations based on historical information because it gives you the information you need: your company's market price and its marketability.

On the other hand, if you wish to sell the business to employees or perhaps a child, a less market-driven valuation is usually more appropriate. Again, if your advisors are unable to help with this type of evaluation, we encourage you to click here to request information about advisors in your community who can help you.

Without knowing the value of your company or the amount of after-tax cash you can expect to receive from its transfer, it is impossible to determine if your financial objectives can be met. If your objectives cannot be met at present, the valuation will tell you how much your company must grow before you can exit. This assessment naturally leads to Step Three.

Go to Step Three

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