Experienced business owners recognize the importance of tracking and monitoring their firm's value over time. They know this business is one of their largest assets, and by measuring and monitoring it, they are enabling its growth, protecting its value, and ensuring a sustainable - and profitable - future. Understanding value and monitoring it over time is the starting point for every business plan: organic growth, acquisition, succession, talent recruitment, everything.
You have every reason to perform regular professional valuations of your business, but here are 10 of the most critical reasons every business owner needs to know and understand their value–in no particular order.
1. Business Growth & Planning
To cultivate intentional growth–by whatever means–and increase the value of your business, you need to have a place to grow from. An comprehensive, professional valuation will help you identify value drivers, growth opportunities, and areas for improvement. These key performance indicators (KPIs) allow you to create an informed growth strategy and focus your efforts to maximize impact and improve production and performance.
Even if you’re not planning on active growth efforts, tracking baseline value year-over-year enables you to monitor business health and ensure its not falling below industry growth and into attrition.
2. External Sale of Business
Next we have perhaps the most obvious reason to discover value, the sale of the business. Of course, when selling your business to a third party, an accurate and fair assessment of market value is an important element (among others) of setting a price for the sale. A comprehensive valuation will look at more than just revenue to provide an opinion of value for your unique business including, but not limited to: revenue sources and predictability, location, infrastructure, and client demographics.
The business value of an acquiring firm is just as important as the value of the practice being acquired. As a buyer, value is essential for developing an acquisition plan that sets realistic targets and aligns with your specific growth goals.
It helps you determine the size of acquisition accessible to you and choose the best targets. Valuation for the purpose of acquisition considers not only revenue, but the revenue-producing mechanisms of the firm, reflecting what types of acquisitions would fit within the existing infrastructure, capital, and service capacity of the buyer’s business. With a strong understanding of your business’ value, you’ll be able to better articulate alignment to a seller and improve your chances of acquisition success.
4. Continuity Agreements
Without knowing the value of your business, you will be hard-pressed to set up an effective continuity plan intended to protect your clients, cash flow, and value in the event of sudden death or disability. Strong continuity agreements cannot be established without a professional valuation. Value informs the deal terms of the plan, if triggered, and establishes how the exiting owner or their estate will be compensated for the transfer of ownership. The business’s value is also the foundation of any supporting insurance policies set up to support and finance the plan.
A professional and comprehensive business valuation is required for credible and defensible use in a variety of litigious circumstances including: divorce, partnership dissolution, bankruptcy, or other legal matters. Since your advisory business is considered an asset, its value needs to be included in an assessment of your personal worth. It is especially important in these situations to apply an opinion of determined value using methodology and details specific to your purpose, such as allocation of assets or personal wealth assessment. Applying a multiple of revenue or even a valuation performed for a different purpose is not sufficient for an informed legal ruling.
6. Expenses and Team Compensation
Professional valuations allow you to bring expenses in line with your priority business objectives. You’ll be able to better prioritize resources and technologies as well as ensure you’re being competitive with your complete compensation packages. Tracking value annually and monitoring growth year-over-year will help you make data-driven decisions about appropriate wage increases, bonuses, and potential equity offers that reward your team for their impact on that growth.
7. Transferring Internal Ownership
Speaking of authentic equity buy-ins. As you establish equity opportunities for top talent, a clear value of what they’re buying into will help reduce anxiety in making the commitment and investment and ensure their retention in the business. Business value establishes a set expectation of ownership investment and timeline of the buy-in note. Additionally, monitoring value over time can help your ownership team assess the success of your transition and help you make any decisions about plan adjustments or accelerations.
Understanding your business value for the purpose of internal investment is crucial when establishing internal succession. It is dangerous to simply guess at business value in any, but especially, this situation. Without value determined expressly for internal transition, you could be drastically over- or under-valuing the worth of an ownership percentage, which could lead to disputes or plan failure.
8. Synthetic Equity
The use of synthetic equity opportunities as an alternative to actual ownership buy-in, are increasingly more common in the financial services industry. Rewards based on business performance are powerful performance incentives and retention tools for top industry talent.
A synthetic equity agreement–regardless of timeline, mechanism, or metrics–can not be drafted or executed without business value. Period. The financials of the agreement are based on how the business’ value changes over time and the tracking of how an individual impacts that growth. A regular assessment of value is a built-in part of that process.
Planning a merger with one (or more) other businesses requires a professional valuation for many of the reasons we’ve already talked about, but also to determine what the ownership of the resulting entity will look like.
The process involves valuing each business separately and then as a new combined entity in order to determine appropriate allocation of ownership as well as the value assigned to each “membership unit” of the new business. This valuation evaluates the size and value of each participating firm and determines the weight of what each entity and owner brings to the table in terms of client base, assets, skill sets, and other factors.
This information is then used to determine key operating factors of the new entity including incorporation of future owners, transition of exiting owners (for retirement, termination, or unexpected death or disability), and decision-making powers for various levels of ownership.
11. Bank Financing
If you’re leveraging bank financing for an acquisition, merger, or internal buy-in, you’ll need to know the accurate value of the business for that purpose. These types of loans aren’t like a simple car loan, they are concerned with the strength of the deal and what the post-transaction business is going to look like. The future state of the business is the collateral they’re staking their financing on. Both SBA and Conventional lenders require professional valuations–for the purpose of the specific transaction type–to approve financing.
Nailing Your Firm's Value
For every plan and purpose, there is a uniquely appropriate method for determining that value. One that considers not only the details of the business, but the details of the situation including the demand and implication of value within it. Simply applying a multiple of revenue is not an accurate reflection of value.
At the very least, valuation and benchmarking reports should be performed annually in order to track the growth and progress of your business. Armed with that you can assess, analyze, and adjust your priorities as necessary. But better than that, accurate and appropriate valuation assessments are the springboard for intentional and targeted efforts to not only grow, but level-up, your business. Valuation can empower you to create a business capable of realizing incredible worth and spanning generations of ownership.
Regardless of your size, structure, and long term goals, establishing your value should be straightforward. There are a lot of misconceptions or inaccurate solutions for effectively measuring, marking, and mastering your firm's value. That's why our team at FP Transitions is focused on making this information easily accessible. Our methodology is clear, consistent, and reliable. With our team of licensed business appraisers, CFAs, and professional analysts, and a database of more than 15,000 certified business valuations, we're an unmatched valuation and benchmarking powerhouse.
A valuation starts it all.