How to Properly Measure Business Owner Resources

Submitted by John Brown on Fri, 07/26/2019 - 9:30am
A woman’s hand writing on a piece of paper between two laptops, one of which shows a screen with graphs and says “Company’s Growth.”

Last week, we proposed the concept of shaping a business owner’s Exit Plan, rather than creating it. We argued that the best place to start is by establishing an owner’s objectives. Once owners and advisors set those objectives, it might be tempting to start strategizing for how to achieve them. But before any advisor can begin strategizing, they need two more pieces of information.

Before owners and advisors can shape an exit strategy, they need to know the owner’s resources in terms of what they have and what they spend.

How to Measure an Owner’s Resources

For most business owners in the lower and middle markets, the business itself is the owner’s most valuable resource. While owners work within the business, it’s their income and perks that have immediate, tangible value. As owners and advisors begin to shape an Exit Plan, owners must confront the fact that what the business is worth to them rarely lines up with that the business is worth to others.

In many cases, owners believe that their businesses are worth more than they objectively are. They may have heard of a competitor who sold their business for X dollars and assume that their business must also be worth X dollars. They may have gotten a valuation years ago and still think it holds water. There are many ways for owners to misinterpret their businesses’ value, but one thing always holds true.

Unless advisors know how to get an accurate valuation for business owners, there’s no way to adequately shape an Exit Plan.

To properly measure an owner’s resources, advisors must help owners do two things.

Get a proper business valuation

Knowing the objective value of a business does two things. First, it gives owners a foundation on which to build their Exit Plans. Second, it shows owners any gaps they may have between the resources they have and the resources they need to properly shape an Exit Plan. It’s the second fact that often gets owners to act.

There are different types of valuations. For example, advisors could suggest an opinion of value by a credentialed business appraiser. This is the most extensive and expensive valuation, and it can be used in US Tax Court. However, at the outset of Exit Planning, Exit Planning Advisors rarely use this level of valuation, unless the company is going to be transferred in the short term.

For planning purposes, Exit Planning Advisors tend to use a calculation of value from a credentialed appraiser. It’s accurate and costs considerably less than a full valuation. Also, when owners intend to transfer ownership an insider, they revise the calculation of value or replace it with a full valuation.

Finally, for small companies at the outset of planning, many Exit Planning Advisors use valuation software to give owners a general idea of value. Though it is not a true valuation, it is useful. Anything is better than relying on the owner to opine on the value of their own company. When advisors know that the owner wants to sell to an outside party, advisors will typically ask an investment banker they work with to provide an estimate of likely sales price. This is usually viewed as more accurate than a valuation because it reflects what is happening in the Merger & Acquisition market today, in the owner’s business sector and geographic area.

When owners realize that their businesses are missing something—in this case, an element that gives the business a value that the owner can turn into financial security—they tend to act. They act not only to eventually achieve financial security but also to make their businesses the best they can be. Most business owners take pride in building a strong business. When they realize it can be stronger, they want to do everything they can to make it stronger.

Advisors must expect to work with a trustworthy, top-notch business valuation expert when shaping their clients’ Exit Plans. They must also expect resistance from owners. Typically, owners resist valuations because they believe they’re too expensive. Advisors can overcome this resistance by explaining that the cost of a valuation is often offset by the improvements owners and advisors make to increase business value.

Put another way, a proper business valuation is an investment in future success. An improper valuation (gut feeling, rule of thumb, etc.) is a straight gamble with the most valuable asset owners have.

Quantify an Owner’s Non-Business Assets and Spending

The second prong of measuring an owner’s resources is to quantify the owner’s non-business assets (e.g., investments) and spending. Quantifying non-business assets is usually the easier half of the equation, as it’s often a matter of tracking down and adding up everything the owner possesses outside of the business. It’s the second half—quantifying spending—that can be challenging.

Earlier, we mentioned that when an owner works within the business, salary and perks provide tangible value. When shaping a business exit, owners must understand that salary and perks tend to disappear once they’ve exited the business. Most business owners don’t factor things like the perks they take when they start to shape their exits, which can cause undue surprise down the line.

To avoid these surprises, Exit Planning Advisors include financial advisors on their Advisor Teams (or if they provide financial services themselves, they provide that service). This lets owners accurately quantify their non-business assets and spending. With accurate quantifications, owners know the size of any financial gaps between what they have and what they need. They can then act, either by increasing business value or non-business-asset value (oftentimes both).

You’ll notice that we don’t suggest that owners simply spend less after they exit. Most owners expect to maintain their lifestyles after they exit. Many want to do even more after they exit, whether that means recreationally for themselves or charitably for others. Besides, with proper valuations and resource quantification, owners and advisors can build value instead of pinching pennies.

Getting a business valuation and quantifying resources and spending are the next important task after establishing objectives. Proper business valuations and resource quantification give owners a baseline for planning. Quantifying spending brings the consequences (good and bad) of an exit into stark relief. But unless advisors convince owners to do these things and then show them how to do it, most won’t act.

Next week, we’ll discuss how to use established objectives and properly quantified resources to guide owners toward their ideal Exit Path.

Takeaways

  • Business owners and advisors may be tempted to begin strategizing after setting objectives. However, they must measure an owner’s resources in several ways before strategizing.
  • Proper business valuations give owners an objective idea for what their businesses are worth, which sets the road map for a successful exit.
  • Quantifying non-business resources and spending is a critical element of shaping an exit strategy.
  • Exit Planning Advisors work with business valuation experts and financial advisors to provide owners with an accurate understanding of what they have vs. what they need.


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