You can be proud of the business you’ve built and its success. You’ve worked hard, so you want to make sure that the business plans you have for the future can be realized.
There are three key components to effective planning
- Knowing the value of your business.
- Protecting your business and your key employees. Business succession and business protection plans allow you to prepare for the unexpected, as well as the future success of your business. And, retention and retirement solutions can also help you and your valuable key employees.
- Protecting your lifestyle. Retirement, income protection and legacy and estate planning solutions help you and your family maintain your lifestyle.
So what’s the first step?
Because the value of your business is such an integral part of effective planning, understanding the value might be a great place to start. You probably have a good idea of what your business is worth. But, if you’re like a lot of other business owners, you may not have ever had your business valued.
An informal business valuation might help you get started towards protecting your business’ future success. We provide complimentary informal business valuations.
We can also help you with the rest
The valuation that we provide is primarily intended to help you with the protection aspect of the planning process — protecting your business, your key employees, and your lifestyle.
Protecting your business and key employees
An important part of planning for the future includes having a formal business succession plan in place. It’s the best way to help ensure that your business will continue in your absence, and on your terms. This is something many business owners don’t address. In fact, 44% of growing businesses don’t have an exit or continuation plan in place.1 Even though the top two transition events identified in a buy-sell agreement for businesses are death and disability of an owner, many buy-sell agreements we’ve reviewed fail to make these triggers “mandatory” events. Death is a mandatory buy-out event for 71% of agreements. But for disability, that percentage drops to only 34%.2
Protecting your lifestyle
Protecting the value of your business is also key. It’s important to your company’s overall success should something unexpected happen. You also want to protect the business because it’s likely a source of income for you and your family, as well as planned retirement income for you. We know this type of planning is easy to overlook. That’s why we’ve identified some planning solutions to help you get started.
Our comprehensive report is meant to be a planning guide for the long-term future of your business. We’ll start by overviewing why knowing the value of your business is so important. Then we’ll highlight possible solutions and next steps needed to create effective plans specifically designed to suit the needs of your business. And, knowing you probably can’t do everything at once, we’ll help you prioritize your next steps and get the planning process started.
Know the value of your business
Determining the value of your business is the starting point and an integral part of the planning process. There are many different methods to value a business, but there’s no one method that’s always appropriate. At the end of the day, the “fair market value” of a business is the amount agreed upon by a willing buyer and a willing seller. Neither party is under any compulsion to buy or sell, and both must have reasonable knowledge of all the relevant facts. This is a common definition used for valuing a business, but we’ll try to add a little more clarity to it below.
Valuation approaches and methods
Business valuation methods are generally categorized under three approaches: asset approach, income approach, and market approach. Since no single method is most appropriate for valuing every business, it’s common to reference a business valuation method under any one or all three approaches.
This is typically used with businesses that have substantial tangible assets, usually in the form of inventory and equipment. It’s most appropriate for businesses with a substantial amount of fixed assets.
- Adjusted book value: This generally represents the “liquidation” value – assets, with adjustments, less liabilities.
This type of approach uses prior earnings to estimate company value based on income potential. It’s most appropriate for businesses with consistently strong earnings. Specific methods include the following:
- Capitalization of earnings method: Applicable for consulting-type businesses and/or those with few or no tangible assets.
- Excess of earnings method: Generally for manufacturing-based firms with significant assets.
- Discounted cash flow method: Uses projected values. Projected future earnings are forecast, then discounted using an appropriate rate representative of the “next best investment opportunity” with a comparable level of risk. Used mainly for mergers and acquisitions.
- Multiple of discretionary earnings method: Applicable for more service-oriented firms, such as legal, accounting, healthcare systems, dental, engineering, etc. Goodwill of the owner(s) has a significant impact on value.
This is based on the prices of similar or comparable businesses that have recently sold. This data is more challenging to find for the sale of small businesses and professional practices, rather than for large businesses. A valuation using this method is not provided in this report.
Considerations for valuing a business per IRS Revenue Ruling 59-60
- Nature and history of business
- Outlook of the economy and the specific industry
- Financial condition of the business and its book value
- Earnings capacity of the company
- Nature and value of any intangible assets of the business, such as goodwill
- Relative size and block of the business interest to be valued and any prior sales
- Market price of actively traded stock of corporations in the same or similar business
1 2019 Principal Financial Group® Business Owner Survey, conducted by Harris Insights & Analytics.
2 Review of 1,561 buy-sell reviews by Principal Financial Group (1/01/2014 to 1/31/2018).