Valuations provide more than simply giving you a number. They help you plan for the long-term to ensure the company provides the value needed when the time comes for you to exit the business.
Although your business is likely your most valuable asset, I have found most owners don’t know the true value of their company. Making things more difficult, the owner’s perception of value can be quite different than the market value. Importantly, this perception can swing either way — owner perception could over-inflate the business’ value or owner perception could be much lower than actual value.
If you don’t know what your company is worth, how will you know when you have enough value to retire? Without knowing the levers that improve value, how can you make sure you are increasing the value of your company each year?
Valuations are incredibly powerful tools to help guide the decisions you make throughout the entire lifecycle of business ownership. Let’s take a closer look.
When is a valuation required?
There are many situations where a valuation is required. Generally, these support some type of transfer of value and include:
- Transfers (or gifts) of stocks to existing or new shareholders
- Forming an ESOP
- Charitable contributions
- Death (or exit) of a shareholder
- Equity compensation valuations
For these situations, owners often research and select a qualified company to conduct the valuation. The valuation is often a one-time event to support the action required.
While not required, when is a valuation a really good idea?
For those who are considering selling their business, a key early step in the process is to conduct a valuation. Given the company is usually a significant source of the owner’s retirement funds, it is prudent to confirm the value range (and likely set of potential buyers). That way there are no surprises as you enter the sale process on what the proceeds might look like and whether there is enough value to support your goals.
Valuation as more than an ad hoc tool: Developing a best practice valuation process
Let’s assume that none of the above situations apply to you. Taking this further, what if you have no desire to convey ownership or sell your company at this time or at any time in the near future. Should you still consider conducting a valuation?
If this is your situation, best practices would suggest that you should consider the use of a valuation process to guide your business. Here is why:
When people come to me to discuss valuation and a potential exit, they generally know two things: how much money they need to retire (usually expressed in terms of annual cash needs) and how much longer they want to work. Unfortunately, most come to me when the timeline to retirement is near. As such, they often tell me “I need $X Million from the sale of my business to support my retirement”. Unfortunately, your retirement needs and the value of your business are mutually exclusive amounts.
The problem with this approach comes down to timing. It is difficult to alter the value of your business in a year or two. A better approach is to look at your company as an investment and set long term goals for value. To do this, you need to understand what it is worth today. You then need to identify your future value goals at retirement and how far into the future you plan to retire. Armed with a current status, a long-term goal and a timeline gives you what you need to develop a plan for when you want to exit the business and be assured that the value will be there for you. This type of planning can also guide the timing for transitioning leadership to someone else in your company if your desire is to keep the business in the family long-term.
Ensure you are creating business value each year
Let’s explore goal setting for company value a bit further. I tell owners all the time that they should look at their company as an investment, no different from any other investment they have in their portfolio. Along those lines, they should have return goals for their company investment as well.
A typical question I ask owners is “are you increasing value in your company each year?” While most say “yes”, they struggle to explain how they know this. Are you sure that you are increasing value? It is surprising to me is the number of companies who don’t use rigorous methods to measure the actual change in value. Taking this further, are you and your employees aligned on what factors will be most important to increase value?
To answer these questions, best practice suggests you conduct an annual valuation update. It should be done at the same time each year — following year-end close is best. It should also use a similar methodology each year so the results are comparable. Valuations can support value creation in the following ways:
- Understanding Value Factors. Valuations should be more than just a number. It isn’t too helpful if you are simply told what you are worth. You also need “the why”. This will highlight the most critical factors which influence value. From this, you can develop a roadmap strategically to address factors which have the biggest impact on value.
- Employee Alignment. Is there agreement on what are the most important actions to focus on each year? It may be growth in a certain geography, retention of a certain set of customers, improvement in plant operations, or increasing your contract renewals. Whatever the factor, you should tie employee compensation to the achievement of these goals. By linking value factors to employee performance, you can ensure achievement of value creation.
Selecting the right company to conduct the valuation
Every industry is a bit different in how it looks at value and each industry has their own factors which can influence the outcome. Understanding the competitive landscape, and each company’s position in the market is essential to understanding value. When you select a vendor, make sure they can provide you the following:
- A value range. A quality valuation requires a lot of science with some art mixed in. As such, it isn’t a single number. It is a range of value which depends on a number of factors. Your valuation vendor should be able to narrow that range for you and indicate where your company lies at this time and why.
- A thorough review of “value factors”. There are many factors which enhance value and there are also factors which can mitigate value. You need to understand your company’s current position with each factor. It will help provide you to develop an effective roadmap for value creation moving forward.
- A review of potential buyers. In our industry, certain companies are best suited to certain buyers. The culture, product/customer mix and geographic coverage can all influence who is the “best-fit” buyer. Even if you are not looking to sell, it is critical to understand who may be most interested in your company. Strategic decisions you make moving forward can reinforce factors that the “best-fit” buyers will pay value for when you are ready to sell.
- Actual results. Can the vendor demonstrate how their valuations compared to actual values received from competitive offers? That is the true test of the quality of the valuation.
Valuations provide more than simply giving you “a number”. They help you plan for the long-term to ensure the company provides the value needed when the time comes for you to exit the business. As a result, we encourage you to establish an annual review process now. We also urge you to do your research and select a high-quality vendor. They should be able to provide a valuation which gives you both a current status as well as guidance on key factors which can influence value to ensure achieving your long-term goals for value.
Envise Partners is an advisory firm which helps industrial laundry companies increase the value of their business. To learn more visit EnvisePartners.com.
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