Ownership Transition: Valuation is Key to Succession Planning

Most business owners spend a lifetime building their business. When it comes to succession, business owners need to weigh the benefits and detriments of a variety of potential exit strategies. This could involve selling to either a strategic or financial buyer; transitioning the business to family members; selling to key employees; or even dissolution. Determining the most appropriate exit strategy involves several complicated issues. Tax matters, as well as family and employee well-being, tend to hold significant importance. Analyzing whether to transfer the business in its current state or transfer components should also be considered.

When planning for succession, the business owner needs to engage experienced financial advisors — starting with a business valuation expert — to review the company’s financials, expected future opportunities, and determine its market position. A skilled business valuation expert can help business owners and advisors customize solutions to meet their individual needs.

Economic conditions affect value

Before drafting a succession plan, a business owner, along with his or her valuator, must consider how current market conditions affect value. It is important for valuators to maintain some level of market neutrality and not be overly pessimistic or optimistic when weighing economic conditions. Valuations that double-count risk factors, for instance, could undervalue the business. On the other hand, valuations that don’t properly account for risk may overstate value.

Some variables that affect value include:

• Expected Cash Flows – Expected future earnings are a key value determinant when implementing both market and income valuation approaches. Expected cash flows will be affected in the event a business foresees decreasing, or increasing, demand and rising (or falling) prices.
• Expected Growth – Revenue and/or earnings growth above or below peer expectations is impactful to a valuation conclusion.
• Perceived Risk – In general, market factors impact the trajectory of industry participants. The magnitude of the expected trajectory impacts the implied risk in achieving forecasted results. Greater risk results in higher discount rates (under the income approach) and lower pricing multiples (under the market approach), which translates into lower values (and vice versa). A valuation expert should work with management to understand the assumptions behind its forecasted activity to accurately capture the inherent risk in the projection with correct discounting and/or multiple selection.
• Marketability and Control – The marketability or access to the liquidity of a business creating the need for succession planning impacts a valuation conclusion. A valuation expert must analyze the marketability of the subject asset to determine if discounts for lack of control and/or marketability should be included in the analysis.

A good plan is an insurance policy

There’s no time like the present for business owners to start — or revisit — their succession plans. They may find facing the future difficult. But if an owner fails to make a succession or estate plan, the same company intended to fuel his or her family’s future could instead become its burden.

We can help get the ball rolling. Contact us if you would like to discuss your succession plan or exit strategy.