The importance of business valuation in succession planning

Succession planning is a critical process for business owners who are looking to transfer ownership smoothly. However, it’s hard to talk about succession planning without considering the importance of business valuation.

Valuation plays a crucial role in ensuring a fair and well-informed transition of ownership. In this article, we will explore why business valuation is imperative in the succession planning process and how it can benefit business owners.

Clarity on the worth of your business today

As a business owner who has dedicated years to building your company, you may not have a clear understanding of its current value. Without a proper business valuation, it can be challenging to approach your succession plan. Here are a few reasons why valuation is essential:

  1. Understanding Third-Party Value: A business valuation provides clarity on whether your business holds value for potential third-party buyers or successors within the company. This information is crucial for making informed decisions about your succession plan.
  2. Accurate Value Assessment: Without a formal valuation, you might overestimate or underestimate the value of your business. Both situations can lead to problems down the line. A proper valuation helps you determine the true worth of your business and avoid such issues.
  3. Identifying Value Drivers: A comprehensive valuation not only provides a figure for your business’s worth but also helps you understand the factors that contribute to its value. By identifying these value drivers, you can strategically plan for your succession effectively.

Increasing business value before exit

Business valuators possess expertise in identifying the drivers that enhance the value of a company. Starting your succession planning early allows you to capitalise on this knowledge. With expert advice and ample time, you can strategically grow your business to increase its value before you exit. This not only helps you achieve your retirement goals but also provides for your family’s financial well-being.

Empowering a smooth succession

In many cases, a significant portion of a business’s value can be attributed to a few key employees. If these employees leave when the business owner retires, much of the value can be lost. To avoid this situation, a careful succession plan must consider these factors.

Transferring ownership to key management or family members can be viable options for business owners. Some owners may even choose to sell their businesses to independent third parties upon realising the substantial value they have accumulated over the years.

However, making informed decisions about succession requires a business valuation. By conducting a comprehensive valuation, you gain valuable insights to base your future plans on. There are various methods to calculate the value of your business, including:

  • Times Revenue Method: This method applies a revenue stream multiplier to demonstrate future revenue potential.
  • Earnings Multiplier: This calculation adjusts future profits against cash flow that could be invested at the current interest rate, providing an accurate picture of your company’s value.
  • Discounted Cash Flow: Similar to the earnings multiplier, DCF considers projections of future cash flows and inflation.
  • Book Value: This calculation showcases the value of shareholders’ equity by subtracting liabilities from assets.
  • Liquidation Value: This calculation determines the net cash value if all assets were liquidated and debts paid today.

Each of these calculations presents a unique perspective on your business’s value and helps you consider different options when creating your succession plan.

Conclusion

8 out of 10 small and medium-sized enterprises (SMEs) are not aware of the value gap risk they face. A value gap refers to the difference between your business’s current worth and the value needed to achieve financial independence.

Understanding the value you are creating is crucial for planning your succession effectively. By conducting an independent business valuation, you can assess the current value of your business and determine the steps required to bridge the value gap.

An agreed-upon valuation formula can provide transparency and structure for employees or other shareholders to gradually buy into the business. Additionally, this formula can be used in shareholder agreements to address disputes or unplanned exits.

At KMT Partners, we offer a range of business valuation services to help you determine the true value of your business and identify areas for value improvement. Our expert team can assist you in evaluating your business’s worth and guide you in maximising its value throughout your succession planning journey.

Remember, a higher business valuation not only enhances your succession plan but also opens up better retirement options when you decide to sell your business. Contact KMT Partners today to start your business valuation process and extract the maximum value from your business with minimal stress.

About our adviser: Michael Fox has been dedicated to the success of his clients, devising comprehensive wealth strategies for both personal and business growth for over 30 years. With extensive expertise in business governance and family business succession, Michael specialises in empowering emerging businesses and family enterprises by fostering renewal, enhancing value and smooth transitions to the next generation. Please do not hesitate to reach out if you need assistance with your business valuation.

This is general advice only and does not take into account your financial circumstances, needs and objectives. The article should not be relied upon as specific information or advice without obtaining appropriate professional advice after a detailed examination of your particular situation from a qualified KMT adviser.