Purpose, perspective, and premise are the foundations of business value. With these three key aspects we can weigh an incredible amount of detail and data to determine the most accurate value of the business–for any circumstance. The more accurate the value, the better the outcome of your situation, and the better your ability to plan ahead for future growth and higher profits.
Everything starts with “why.” What is the purpose for the valuation? As we like to say, “value is in the eye of the beholder,” and purpose allows us to pinpoint that perspective to know what makes a business valuable to them. And when we drill down into situational specifics and the nuances of perspective, we can understand the future-state of the business and the premise of the valuation to fine tune its accuracy.
There are many reasons you might need to know the value of your business, but the most common–especially in the financial services industry–are: external sale, internal succession, and business planning. By exploring these common scenarios, you can better understand how purpose, perspective, and premise are leveraged in the valuation process for any reason, and why they are so critical.
PURPOSE: External Sale
Value does not equal price, BUT it is an important starting place to determining what to ask for in the sale of your business.
Understanding that your purpose is to sell your business, we then know that the perspective we’re valuing from is that of your buyer. Which aspects of your business are most important to an external buyer? The majority of your business value lies in the clients, the AUM, and the revenue generated therein. As we are valuing from the perspective of the buyer, this particular purpose almost always uses the Fair Market Standard. This standard relies on applying behaviors and assumptions reflected by real-life transactions of similar industry, size, and structure.
As for premise, those details lie in a variety of places, including whether there will be an open market search or a private buyer, specific seller criteria for the sale, the seller’s intention to conduct a Sell and Stay transaction, or whether a buyer is likely to maintain the existing team and office or not. These nuances will affect what the business will look like post sale, contribute to buyer’s desirability, and determine overall value.
If a buyer is likely to simply absorb the business’s clients and not maintain an existing office, then the staff (and their expertise), the established efficiencies of the office, and the physical assets of the business do not contribute much to the value of the sale. However, if the seller has built a talented team who wish to transition to the new business, this must be considered in the valuation as it translates into higher client retention rates, improved capacity, higher expenses, and improved revenue potential from expanded expertise.
The value of your business with the intention to sell is not as simple as applying a multiple of revenue or taking your best guess. Accurate value for the appropriate context benefits both buyer and seller.
PURPOSE: Internal Succession
Internal succession is the process of transitioning a percentage of ownership to key team members already within the firm. The purpose of the value here is not to help determine the outright sale price of the business, but to help determine things like what percentage of equity to transition, buy-in price, and profit distributions.
The perspective of value in this case are the new members of the ownership circle–internal successors who are investing in the future value of the business. Internal succession valuations almost always use the standard of investment value using an income-based approach. The key considerations here are how likely investors are to receive ongoing profit distributions, value appreciation over time, and the future cash flows of the business.
Due to the fact that this scenario has a lot more to do with the people involved than an external sale, the details of the transaction are often extremely nuanced. That’s why valuations for this purpose are often sought when owners already have a good idea of who their successors will be. The premise of these valuations often considers factors like how many new owners are being added to the equity circle–and in what percentages–, what is the expected tenure of existing ownership, and how motivated are the new owners to generate growth.
As with an external sale, there is still significant value in the AUM and revenue of the business for the purpose of internal succession, but factors like client retention, physical assets, and geography might not be as large a concern. Instead, the future-state of the business–not just post transaction, but in the years to come–is extremely important and aspects that are of little concern in an external sale, hold much more interest to an internal investor and new owner.
PURPOSE: Long-Term Business Planning
Business planning should be the most common reason for valuing a business. Determining value as a starting point for growth and a foundation for benchmarking analysis is an essential tool for making strategic business decisions.
The purpose in this case–to monitor growth year-over-year and to take action to drive that growth–might feel a little vague when compared to more defined reasons of selling or adding new owners. But it just that quality that makes these valuations so powerful. You may have a goal of bringing on more owners one day–and that certainly becomes a consideration in the process–, but you also have infinite possibilities open and a plethora of paths you could follow.
The perspective here is yours. As a business owner, you’re making informed decisions and you’re the one who is wielding the valuation and benchmarking insights at hand. Valuations for this purpose often (but not always) employ a market approach as it provides a more consistent set of data that makes the year-over-year comparisons easier.
Valuations performed early and regularly in the life of your business can ensure your future value is high no matter the “beholder.” Regardless of how your plans solidify or evolve, understanding your value and how it compares to other business today, allows you to make a focused effort and have maximum effect on how it grows.
There are many reasons why a business valuation might be required, and more still when you look at all the variables in play for any given scenario. Whether the reason is to solidify your business plans or sell your business–or even whether it’s to merge entities or solve a partnership dispute–the valuation process ALWAYS considers purpose, perspective, and premise to contextualize the big question: “What is my business worth?”
FP Transitions valuation reports are backed by an extensive database of over 12,000 valuations and a team of valuation professionals. An Assessment of Business' Equity Value is a core benefit of our Equity Management Solutions ® Professional annual membership program, along with yearly continuity plan reviews and benchmarking reports (included with EMS™ Professional level members and at a discount for EMS™ Essentials level membership).