What’s Your Company Worth?

An Introduction to Advanced Planning for Business Owners

This article was co-authored by Anthony Perillo, financial advisor at Wipfli Hewins Investment Advisors.

For many owners of closely held businesses, their business is their retirement plan — understandably, saving for retirement can often take a backseat to investing more capital in the business, and the proverbial retirement-planning can gets kicked further down the road. Though an eventual sale of their business interest may provide a windfall large enough for long-term financial security, it’s still essential for business owners to understand the value of their company, now and in the future, to make informed financial decisions — both on a personal level and in managing their business.

Often, the most important determining factor in the success or failure of a financial plan for business owners is the “magic number”: the proceeds from selling the business (after-tax) that are necessary to meet all critical financial goals. Without knowing this number and how it relates to the current value of the business, a business owner can risk making blind decisions that may not be in his or her best interest.

What's Your Company Worth? An Introduction to Advanced Planning for Business Owners

Even for those business owners who don’t need to rely on a sale for retirement — those who may have been fortunate or savvy enough to accumulate sufficient assets outside the business — having a solid grasp of the value allows for more efficient and proactive transfer planning.

Regrettably, many owners do not pay attention to the value of their company until it comes time to sell or transfer their ownership interest, which is often too late and can lead to poor sale outcomes. Putting together a thoughtful plan and taking the time to improve the company are key elements in driving the value and successful sale or transfer of the company. It is vitally important for a business owner to understand what constitutes value in the marketplace — namely, how a potential buyer will value their company.

Too often, owners believe the value of their company is directly correlated with the amount of “blood, sweat and tears” they have put into it. Unless those efforts can be monetized, a prospective purchaser is probably not interested in an owner’s humble beginnings or legacy. A prospective buyer, however, does care deeply about the company’s risk profile and return potential — both of which are the foundation of how the value of the business is defined. The higher the return potential of a company, the higher its value; likewise, the lower the return potential of a company, the lower its value.

Additionally, the lower the risks associated with the expected return, the higher the value of the company; the higher the risks associated with the expected return, the lower the value of the company. These risks can be internal (i.e., customer concentration, limited management team, etc.) or external (i.e., economic environment, regulatory environment, etc.).

Another important consideration is that buyers may value a business based on what they expect to happen after the close of the sale. Historical financial information is important to the extent that it may be a guide for future performance, but a discerning buyer will also carefully consider how the company and industry will change over time. For example, think of the printing industry: a printing company may have positive historical financial statements; however, in a world that continues to move away from printed materials toward digital mediums, the future performance of a printing company may be drastically different than its past.

How buyers define value is similar to the business valuation methodologies appraisers and finance professionals use to measure value — in many cases, businesses are appraised with the same methodologies used to value real estate or equipment or intellectual property. There are three approaches to valuation:

1. The income approach attempts to determine the present value of a business’s future cash flows through the application of a discount or capitalization rate.

2. With a market approach, transaction multiples of similar companies in similar industries are applied to the business’s ongoing earnings. The market approach is similar in theory to how your realtor values your home through the research of sale prices of similar homes.

3. The cost approach simply assigns a value based on what it would take to replace the business with one of equal utility.

There is no single correct method, and multiple methods may be used in conjunction with each other. Most operating entities are valued using the income and/or market approaches, as the value of a company’s intangible assets is captured in its earnings.
The cost approach, on the other hand, typically only focuses on the value of a company’s tangible assets. In the income and market approaches, the risk profile of the business directly impacts the discount/capitalization rate or multiples applied.

As is the case with any other investment, a business’s fundamental value ultimately comes down to risk and return. An owner who knows the value of their company and understands how value is measured can drive their business decisions in support of a more favorable valuation when the time comes to exit the business. They can also take a much more informed and proactive approach to their personal financial plan.

Do you know the value of your company?

 

Hewins Financial Advisors, LLC d/b/a Wipfli Hewins Investment Advisors, LLC (“Hewins”) is an investment advisor registered with the U.S. Securities and Exchange Commission (SEC) under the Investment Advisers Act of 1940. Hewins is a proud affiliate of Wipfli LLP. Information pertaining to Hewins’ advisory operations, services and fees is set forth in Hewins’ current Form ADV Part 2A brochure, copies of which are available upon request at no cost or at www.adviserinfo.sec.gov. The views expressed by the author are the author’s alone and do not necessarily represent the views of Hewins or its affiliates. The information contained in any third-party resource cited herein is not owned or controlled by Hewins, and Hewins does not guarantee the accuracy or reliability of any information that may be found in such resources. Links to any third-party resource are provided as a courtesy for reference only and are not intended to be, and do not act as, an endorsement by Hewins of the third party or any of its content or use of its content. The standard information provided in this blog is for general purposes only and should not be construed as, or used as a substitute for, financial, investment or other professional advice. If you have questions regarding your financial situation, you should consult your financial planner, investment advisor, attorney or other professional. Hewins does not provide tax, accounting or legal services.
Paul Ouweneel
Paul Ouweneel

CFA, CPA, CFP® | Vice President of Valuation, Litigation and Transaction Services, Wipfli LLP

Paul Ouweneel, CFA, CPA, CFP®, is the Vice President of the Valuation, Litigation and Transaction (VLT) Services group at Wipfli LLP, based in Milwaukee, WI. Paul specializes in the valuation of businesses and intangible assets, as well as sale and purchase transaction support for companies in a variety of industries.

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What’s Your Company Worth?

time to read: 4 min