Exit Planning Tools for Business Owners

Valuation

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.

Exploring Business Exit Strategies: Definitions, Examples, and Top Types

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Every business journey has a beginning and an end. Just as you plan how to start your business, it’s essential to plan how you’ll eventually step back or move on. This is where a business exit strategy comes in. Simply put, it’s a plan that helps business owners decide when and how to sell or close their business in an organized way. But, how do you know it’s time? Read ahead to find out.

Understanding Business Exit Strategies: Definition and Importance

A business exit strategy is a well-thought-out plan that outlines how an entrepreneur or business owner will sell, dissolve, or transition out of their business.

So, What is an Exit Strategy in Business?

An exit strategy in business is a business owner’s plan to sell, transfer, or close their business. Think of it as the “exit door” for an entrepreneur. It’s how they transition out, either to retire, start a new venture, or due to unforeseen circumstances.

Knowing how to exit a business is critical because it not only determines the financial future of the business owner but also impacts the employees, stakeholders, and the industry at large.

This plan is crucial for mitigating risks and maximizing profits, especially long-term ones. Understanding a business exit strategy involves knowing its scope, from selling the business to passing it on to a successor.

A business exit strategy is a detailed plan that outlines the steps, processes, and actions required to exit a business. This could involve selling the business to a competitor, passing it on to family members, going public through an Initial Public Offering (IPO), or even winding down operations. Implementing exit strategies for businesses requires foresight, planning, and often expert advice.

Why is an Exit Strategy Important?

An exit strategy is not just an “exit”; it’s a crucial part of business continuity planning services. It offers a roadmap for the business, ensuring sustainability and financial health even if the original owner departs. The process of planning for a business exit offers opportunities to streamline operations, make the business more appealing to buyers, and increase its overall value.

Real-Life Examples of Successful Business Exit Strategies

There are multiple pathways to a successful exit, but a few standout examples can serve as blueprints.

Selling to a Competitor
In 2002, eBay acquired PayPal for $1.5 billion. This was a successful exit strategy for PayPal’s founders, who were able to sell their business for a significant profit.
These are just a few examples of successful business exit strategies. There are many other ways to exit a business, and the best strategy for a particular business will depend on various factors, such as the size and type of business, the owner’s goals, and the current market conditions.

Initial Public Offering (IPO)
Taking a company public through an IPO is another option. For instance, Twitter went public in 2013, providing a profitable exit for early investors and founders.

Mergers
Mergers can be a strategic exit strategy when two companies believe they can be more successful together than independently. A classic example is the merger between Disney and Pixar. In 2006, Disney acquired Pixar in a $7.4 billion deal.

Succession Planning
Not every exit strategy involves selling or going public. Sometimes, it’s about ensuring the business remains in trusted hands. Walmart’s founder, Sam Walton, did precisely that. Before passing away, he divided ownership of the company amongst his children, ensuring the retail giant remained in the family.

Top Types of Business Exit Strategies to Consider

There are many different types of business exit strategies to consider, but some of them are:
Selling the business to a third party
Selling the business to a third party is the most common type of business exit strategy. It can be a good option for business owners looking to maximize their financial return or ready to retire. However, it is important to note that selling a business can be a complex process, and working with a qualified advisor is important to ensure that the sale is completed successfully.

Merging with another company
Mergers with other companies can be a good option for businesses that are looking to grow or expand into new markets. It can also be a good way for business owners to gain access to new resources and expertise. However, it is important to note that mergers can be complex and time-consuming, and it is important to carefully consider all of the implications before entering into a merger agreement.

Going public (IPO)
Going public is the process of selling shares of a company to the public. This can be a good way for businesses to raise capital or increase their brand awareness. However, going public is a complex and expensive process, and it is important to carefully consider all of the implications before filing an Initial Public Offering (IPO).

Passing the business down to family members
Passing the business down to family members can be a good way for business owners to keep the business in the family and to ensure that it continues to operate successfully. However, it is important to plan carefully for the succession process and ensure that the family members who will be inheriting the business are prepared to take on the responsibility. This strategy also allows for long-term business continuity planning.

Shutting down the business
Shutting down the business is the least desirable business exit strategy, but it may be necessary if the business is not profitable or if the owner is unable to find a buyer. If you are considering shutting down your business, developing a plan to minimize the financial impact on yourself and your employees is important.
No matter which business exit strategy you choose, starting planning early and getting professional advice is important. By carefully planning your exit, you can increase your chances of a successful transition.

Crafting Your Business Exit Plan: Essential Steps and Tips

Once you’ve decided on an exit strategy, the next step involves crafting a business exit plan example.

Step 1: Valuation
Begin by assessing the valuation of your business, either through a professional service or self-evaluation methods.

Step 2: Legal and Financial Planning
Legal and financial planning are essential for any business exit plan. This planning phase often involves exit planning services to handle complex transactions.

Step 3: Timeline
Set a realistic timeline for your exit, allowing sufficient time for all transactions and transitions to occur.

Choosing the Right Exit Strategy: Factors to Consider for a Smooth Transition

Several factors must be considered to choose the appropriate exit strategy for business.

Market Conditions
Market conditions can heavily influence the success of your exit strategy. Assess the current economic climate, competitor behavior, and industry trends.
Business Health
Evaluate the financial health of your business. Factors like revenue streams, debt, and assets all play a role in determining how viable certain exit strategies may be.
Personal Goals
Your personal goals and life circumstances will also significantly determine your exit strategy. Whether you aim for quick liquidation or want to ensure long-term business continuity will inform your decision.

Bottom Line

Business exit strategies are fundamental to ensuring a business venture’s smooth transition, sustainability, or profitable conclusion. In order to successfully exit a business, it is important to plan ahead and have a solid understanding of the industry. This may include merging with another company, being acquired by a larger entity, going public, or passing the business on to the next generation. As entrepreneurs and business leaders map out their ventures, considering and planning for an eventual exit is not just prudent but essential for maximizing value and ensuring the continued success of the enterprise.

 

Amit Chandel  is a “Certified Tax Planner/Coach”, and “Certified Tax Resolution Specialist”. He has extensive experience in Tax Planning and Tax Problem Resolutions – helping his clients proactively plan and implement tax strategies that can rescue thousands of dollars in wasted tax and specializes in issues relating to unfiled tax returns, unpaid taxes, liens, levies, foreign bank account reporting, audit representation, and any other type of tax controversy; Financial Consulting; Business Planning, Business Valuation, Forensic Accounting and Litigation support. He is the recipient of the prestigious Certified Tax Planner of the Year Award-2017, bestowed by the American Institute of Certified Tax Planners..