Exit Planning Tools for Business Owners

Exit Planning

How to Value Your Business

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Your guide to the secrets of business valuation and exit planning

Valuing a business can be an extremely complex process when the audience is the IRS or the Court System, but for most business owners trying to get a sense of their business value for the purpose of a sale it is more straightforward.

We’ve created this guide for business owners to gain a better understanding of the fundamentals of business value and spark some ideas around exit planning. This guide focuses on privately held businesses in mature industries, not tech start-ups. This includes “Main Street” businesses to lower middle market businesses. Let’s group them together and call them “SMBs”, a popular acronym to define small and medium-sized businesses. Before we dive into the numbers, it is important to define the key stakeholders.

Potential Buyers

In our experience, SMB owners do not spend much time thinking about the potential buyers of their businesses. There are a number of methods to transition a business, and the method you choose should align with your desired goals, whether it be immediate liquidity, legacy, or both.

Internal – A buyer for the business could be an employee, manager, business partner, family member, or Employee Stock Ownership Plan.

External – Strategic buyer (i.e. competitor), or financial buyer (i.e. private equity)

Internal buyers can be a great way for companies to transition the business, preserve legacy, and reward internal managers, employees, or family for their hard work or loyalty. However, it may take years to develop this succession plan. Owners that don’t consider these options will miss this opportunity.

External buyers will typically pay more to acquire a business due to potential synergies or diminished competition. However, external buyers will exert more control or influence over the future of the business and this may include layoffs or relocation.

Transferrability

Only 20-30% of businesses marketed for sale actually sell according to research by the Exit Planning Institute. Before we get into the attributes of a business that affect its price, you must first consider whether the business can be transferred at all.

The top three reasons for a business not being marketable in our opinion are:

1. Poor financial quality. A business must be able to produce timely and accurate financial statements at a moment’s notice. If a buyer cannot assess the business’ ability to generate cash flow, the business has no value.

2. Owner centricity. If all the trade secrets, relationships, and procedures leave with the exiting owner, the business has no value.

3. Customer concentration. If the majority of business is concentrated amongst a few clients, the business has no value. The loss of one or more of these clients would devastate the business.

If the business has strong financial quality, a decentralized business model, and little-to-no customer concentration, now we have a business that is able to be sold or transferred.

Valuation

Many firms offer “business valuations.” A certified valuation report is written by a credentialed appraiser and assigns value to a business based on an Income Approach, Market Approach, and Asset Approach.

The Income Approach is based on the premise that the value of any asset is the present value of future cash flows. In this method, an appraiser will assess historical cash flows (Capitalization of Earnings Method) or create projections (Discounted Cash Flow Method) to value a business. The cash flow stream is then discounted or capitalized according to the risk free rate of return and various risk premiums including company-specific business risk.

The risk premiums and application of the various methods can be complicated, but ultimately, the income approach is a function of earnings and risk. Risk can be broadly thought of as the risk of the likelihood the earnings will continue in the future.

The Market Approach is based on the premise that the value of an asset is determined by the price of similar assets in the market. Using this approach, the appraiser will determine the appropriate cash flow and apply various multiples. Common multiples for SMBs are revenue, EBITDA, and SDE. EBITDA is an acronym for Earnings before Interest, Taxes, Depreciation, and Amortization. In short, it is a common measure of true cash flow in the business. SDE, or Seller’s Discretionary Earnings, takes cash flow one step further. It adds in compensation for a single owner plus any personal expenses. SDE is more commonly used in Main Street businesses that can be operated by a single owner. EBITDA is more commonly applied to larger businesses with less direct owner involvement and a proper management team.

The Asset Approach is determined by calculating the market value of the assets of a business. This method is typically only applied in a liquidation scenario. In the income approach and market approach, we assume that the value of a business is more than the value of the tangible assets because the assets are used to generate positive cash flow. If that is not the case, the asset approach may be applicable.

Certified appraisers analyze all three methods and arrive at a conclusion of value using one or more of the approaches. Business brokers typically rely on the market approach when determining a list price for a business. Brokers will calculate SDE for 3 years and apply a multiple of SDE. We’ve seen most brokers average SDE over a 3 year period and multiply it by 3 (more to come on multiples). More aggressive brokers will apply the multiple on the best year, or most recent period.

Market multiples for SMBs are published in a handful of databases. The downside to relying on comparable transactions is the limited information. While you can see the transaction price, date, and the market multiples, you cannot get a sense of the qualitative attributes of a business such as strength of management, location, employee tenure, etc. To get a glimpse of businesses listed for sale, check out BizBuySell.

Rules of Thumb

There are a vast amount of factors that affect the multiple a business may receive on the market. To name a few, let’s consider financial statement quality, owner dependency, customer concentration, barrier to entry, capital intensity (the amount of equipment required to operate), location, profitability, management, customer contracts, recurring revenue, etc.

Revenue: 40-60% of annual sales (accounting firms and insurance agencies excluded)

SDE: 2-3.3x

EBITDA: 3-5x

Most main street and lower middle market businesses will fall into these ranges. Generally, the larger the business the higher the multiples due to lower perceived risk. We’ll characterize the low and high end of these ranges:

Low end

  • Retail business relying on walk-in customers
  • Minimal barrier to entry
  • Low capital intensity (no equipment required to operate)
  • Little repeat business
  • Low employee loyalty
  • Business has been entirely dependent on a single owner
  • Low profit margins

High end

  • Annual or multi-year contracts
  • Contracts are documented and transferrable
  • Repeat business
  • Product differentiation
  • High profit margins
  • Superior location with multi-year lease
  • Strong management / no owner dependency
  • Specialized equipment required to operate

Accounting firms and insurance agencies trade a little differently. These businesses typically are priced based on multiples of revenue or annual commissions.

Exit Planning

We hope this guide has provided some transparency and insight into the value of your business. Once you have an understanding of the value of your business, you can better plan and prepare for life beyond the business. The sale of your business is typically a one-in-a-lifetime event and it should be treated as such. Statistically, that has not been the case. According to the Exit Planning Institute and their State of Owner Readiness survey:

60% of business owners do not understand their exit options

30% have no transition plan in place

49% have done no planning at all

80% have not formed a transition advisory team

An advisory team comprises experts in distinct fields all working towards your successful transition. Financial advisors can provide guidance with the amount of after-tax liquidity you need to live the lifestyle you want. Estate planners can help minimize tax impact and provide for your dependents and loved ones. M&A attorneys will guide the transaction and ensure your interests are represented and protected. An exit planning advisor serves to bring the team together, working towards the same goal on the owner’s timeline.

Mark Ahern started Amp Business Valuations in late 2020. He has a background in financial services and a passion for helping small businesses. Mark was formally trained in commercial real estate and C&I credit. He also held posts in retail banking, retail mortgage, and loan operations. Mark earned an MBA from DePaul University and teaches Business Finance at Regis University.

Personal Vision – Life After the Sale Part I

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Life after the sale is often both the most important and most neglected factor in exit planning. Although (according to two different surveys in 2013 and 2022,) 75% of owners report regrets or unhappiness a year after the transition, exit plans continue to be constructed primarily around financial targets. In the event you haven’t heard this since you were five years old, “Money doesn’t fix everything.”

Superficial Planning

To be fair, most advisors include some conversation about “life after” in their planning conversations. Unfortunately, they are often satisfied with the features associated with an abundance of free time. Visiting the family, RV’ing through the country, playing 72 holes of golf a week, or seeing the great capitals of Europe can all be accomplished in the first year after ownership.

When they attempt to broach the idea of longer-term activity, the client’s answer is often “Let’s get the money. Then I’ll worry about what to do with it.” It’s challenging to push beyond the client’s desire to focus on the most obvious goal, especially when it seems to enable everything that follows. Nonetheless, owners who are unhappy because they didn’t get enough money failed either to understand the realities of their transactions or the future cost of their life plans. That certainly isn’t 75% of planning clients.

We are discussing the far greater number who have sufficient funds, but after their initial splurge of free time are unsure of what to do next.

Emotional Preparation

The first issue an exited owner faces is identity. “I used to own a company” quickly wears thin, and increasingly fades as years pass. “I’m retired” is a nebulous identity, and lumps them into a group with every wage earner who says the same. That’s a class they’ve proudly differentiated from for most of their lives.

Some mental health professionals have compared the emotional reaction to missing ownership identity to post-partum depression. Their world has changed overnight. The principal subject of their interest is gone, and they aren’t sure what replaces it. Post-partum is characterized as including “a feeling of guilt, worthlessness, hopelessness or helplessness.”

As an owner, there was always something else that needed their attention. Now there isn’t. Distress from discussing the daily news (which they now watch more frequently) used to be countered by a requirement to attend to the business. Now there is no business to attend to. The feeling of “What I do is important to a lot of people” has gone.

Identity in Life After the Sale

We encourage clients to at least mentally design their next business card. Handing someone your card is a shorthand version of declaring your identity. The first attempt by many is jocular but meaningless. “Part-time Philanthropist, Bon Vivant and Man About Town” is funny, but only once. “Grandparent, Outdoorsman and Classic Car Mechanic” is better. At least it describes real activities for further conversation.

“Business Counselor and Chairman of the Board of (Charity Name)” describes an identity, ongoing contribution to something or someone, and a role of importance. It doesn’t have to be true today (we aren’t printing the business cards yet,) but it’s at least aspirational.

Building a plan for life after the sale begins with establishing a future identity. There are several other components that we will cover in the next two articles.

John F. Dini develops transition and succession strategies that allow business owners to exit their companies on their own schedule, with the proceeds they seek and complete control over the process. He takes a coaching approach to client engagements, focusing on helping owners of companies with $1M to $250M in revenue achieve both their desired lifestyles and legacies.

Exit Planning – Lifestyle and Legacy

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Lifestyle and Legacy are two very different types of owner transition objectives.

When we ask a client “What do you expect as a result of our exit planning?” the answer may be about the money, the time frame, or the impact on people. No matter how it is phrased, the response will break down into one of two major categories. It’s either about the owner’s future lifestyle, or the legacy that is left behind.

Lifestyle Objectives

Many clients want to exit to an enjoyable retirement. Usually, their primary concern is financial security. They want enough money to live comfortably, and to take care of their family. This is the reason many start their process by consulting with a financial planner, but lifestyle objectives can extend well beyond their bank account.

A separate but related objective is time. It may be the time to travel without being chained to a laptop. The time to explore new things outside the business might result in formal education or training. Undertaking a new wellness regimen requires time, as does exploring a new hobby.

Time might be used to engage in community service. An issue that is increasing in the Baby Boomer generation is the time to care for older family members.

Another lifestyle issue is the ability to relocate. Moving to a place for favored activities, a better climate or to be closer to children (and grandchildren) often requires separation from the activities of the business.

Legacy Objectives

Some owners run their businesses for other than purely financial reasons. In these cases, they may be more concerned with how the business continues than the proceeds to be realized from a sale.

Of course, a chief motivation for putting legacy at the top of the list is family succession. It might be a sense of obligation in a company that has already passed through multiple generations, or just a desire to provide future generations with the benefits of ownership.

The role of the business in the community is also a legacy concern. The company could be a key employer in a small town, or a primary sponsor of a school or Little League. The owner’s name on the door or the preservation of long-standing business relationships can often affect the desirability of a buyer in the seller’s eyes.

Environment, Social, or Governance (ESG) concerns have become increasingly important to some sellers. They want to make certain that the importance they place on these issues is shared by future ownership.

Finally, the future growth and success of the business can be considered a legacy issue. An owner could have concern for the opportunities such growth provides to loyal employees, or whether innovations and proprietary processes will be expanded beyond their current limits.

Lifestyle and Legacy

Every owner’s objectives will have some combination of lifestyle and legacy concerns. They don’t necessarily conflict, but they involve differing perspectives.

John F. Dini develops transition and succession strategies that allow business owners to exit their companies on their own schedule, with the proceeds they seek and complete control over the process. He takes a coaching approach to client engagements, focusing on helping owners of companies with $1M to $250M in revenue achieve both their desired lifestyles and legacies.

How to Add Millions to The Value of Your Business – Using EBITDA Adjustments

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As a 5-time entrepreneur who has helped several businesses increase their value, I know what it takes to run a successful business. If you’re trying to figure out what your business might be worth, it’s helpful to consider what acquirers are paying for companies like yours these days.

According to Oberlo, the number of small businesses increased from 32.5 million in 2021 to 33.2 million in 2022. This trend shows no signs of slowing down as more and more people are taking their first steps into becoming an entrepreneur.

In addition to new businesses, many boomer business owners will be heading into retirement within the next decade, adding even more competition for the attention of buyers.

With both of these factors in mind, it is normal for more established organizations to wonder if the increase in new competition will have an impact on the value of their business when it comes time to sell.

While this can be intimidating, there is a process a business owner that is looking to retire can take to ensure a profitable exit.

Obsessing Over Your Multiple

If my 25 plus years of experience has taught me anything, it’s that a business trades for a multiple of your pre-tax profit, which is Sellers Discretionary Earnings (SDE) for a small business and Earnings Before Interest Taxes, Depreciation and Amortization (EBITDA) for a slightly larger business.

This multiple can transfix entrepreneurs. Many owners want to know their multiple and how they can increase its value.

After all, if your business has $500,000 in profit, and it trades for four times profit, it’s worth $2 million; if the same business trades for eight times profit, it’s worth $4 million.

Obviously, your multiple will have a profound impact on how much you will realize on the sale of your business, but there is another number worthy of your consideration as well: the number your multiple is multiplying.

How Profitability Is Open to Interpretation
Most entrepreneurs think of profit as an objective measure, calculated by an accountant, but when it comes to the sale of your business, profit is far from objective. Your profit will go through a set of “adjustments” designed to estimate how profitable your business will be under a new owner.

This process of adjusting—and how you defend these adjustments to an acquirer—is where you can dramatically spike your company’s value.

How to Increase Your Companies Value in Time for Retirement with EBITDA Adjustments.

Let’s take a simple example to illustrate. Imagine you run a company with $3 million in revenue and you pay yourself a salary of $200,000 a year. Further, let’s assume you could get a competent manager to run your business as a division of an acquirer for $100,000 per year.

You could safely make the case to an acquirer that under their ownership, your business would generate an extra $100,000 in profit. If they are paying you five times profit for your business, that one adjustment has the potential to earn you an extra $500,000.

You should be able to make a case for several adjustments that will boost your profit and, by extension, the value of your business.

This is more art than science, and you need to be prepared to defend your case for each adjustment. It is important that you make a good case for how profitable your business will be in the hands of an acquirer.

Some of the most common EBITDA adjustments relate to:

Rent (common if you own the building your company operates from and your company is paying higher-than-market rent).
Repairs and maintenance.
Start–up costs.
One-off lawsuits.
Insurance claims.
One-time professional services fees.
Lifestyle expenses.
Owner salaries and bonuses.
Family members wages and benefits.
Non-arms length revenue or expenses.
Revenue or expenses created by redundant assets.
Inventories

Your multiple is important, but the subjective art of adjusting your EBITDA is where a lot of extra money can be made when selling your business.

Joe Gitto, CEPA is an accomplished senior Finance, Sales and Operational Executive, Entrepreneur, Coach, Thought Leader, and Board Member with more than 25 years of success in various industries.

Stakeholders in Exit Planning

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When preparing for the transfer of a business, there are many stakeholders who can impact your plan. Some have direct authority or decision-making capability over the transaction, but others may have substantial influence. In general, it’s best to presume that anyone who has a relationship with the owner or the business will have some impact on his or her decisions.

Internal Stakeholders

Of primary importance are partners and shareholders. Even when an owner has a voting majority, minority partners may have an official or unofficial veto. “Official” comes in the form of supermajority rights. Unofficial may be in the form of a threat to terminate employment, which in some cases may make the business unsaleable. If the minority holders are the intended recipients of the equity, they will function as both key components of the company’s value, and negotiators of the price to be paid for that value.

Employees are the other major internal stakeholders. Could they be a flight risk in the owner’s absence? Are they in danger of losing special status or privilege under new management? What is the plan for informing and updating them before and after a deal is struck?

Family

With most business owners, their equity in the business is 50% or more of their personal net worth. That makes future ownership, sale price and coordination with the estate plan items of great interest to spouses and children. In today’s serial family relationships, that can also involve step-siblings, former spouses, and their new partners’ families.

If there are children in the business, their future is inextricably tied to the company. If some children are in the business and some outside of it, the entitlements and expectations grow even more complicated.

Business Relationships

Customers may be transactional, as in retail, or strategic partners whose own business depends on what the company supplies. In such cases, or when customers are government entities, they may have contractual rights to approve a change in ownership.

In any case, the valuation of the business is going to depend at least partially on the retention of customers.

Suppliers have similar interests. We recently saw a distribution arrangement canceled simply because the supplier was insulted by not being informed about the company’s merger negotiations. The fact that they were conducted under a confidentiality agreement didn’t appease the supplier.

Creditors and lenders who hold personal guarantees are bound to be concerned about ownership changes. Be proactive in letting them know how their security interests will be preserved.

Public Stakeholders

StakeholderGovernment entities, especially any with regulatory responsibility over the industry, should also be approached proactively. Waiting for them to recognize a change may seem like “discretion as the better part of valor,” but untimely intervention could derail a transaction.

If the company is an important employer, a candidate for relocation, or a fixture in the community, some outreach to elected officials may be advisable.

Finally, consider the media. Plenty of business owners have complained about interviews that were slanted, reported inaccurately, or “just plain wrong.” If the transaction is newsworthy (and even if it isn’t,) prepare a professional announcement and a list of where it should be distributed. Refer to it, word for word if necessary, whenever someone calls for comment.

Thinking in advance about the impact of an exit plan on the various stakeholders can save advisors and their clients a lot of headaches when a deal is signed.

John F. Dini develops transition and succession strategies that allow business owners to exit their companies on their own schedule, with the proceeds they seek and complete control over the process. He takes a coaching approach to client engagements, focusing on helping owners of companies with $1M to $250M in revenue achieve both their desired lifestyles and legacies.