No matter what type of business you run, there’s probably something that keeps you up at night—Is your team happy? Are you providing great services? Will you be in the black this year? Will you still be in business in 10 years? Few business owners give much thought to sale value. But this is actually just as important as the other queries, and can ultimately help drive value and spur greater success. Here are some reasons that receiving a proper valuation is an important component of successful business planning.
Sooner or Later, You’ll Leave
Whether it’s in a year or 25 years down the line, you will exit your business. Receiving an accurate business valuation helps you prepare for this eventuality. Knowing exactly what your business is worth can help you plan for the inevitable future. You need to plan for ideal and less-than-ideal scenarios. A valuation helps you do so.
Many owners think that a valuation is only necessary if they are planning an external transfer—a sale to a third party. But if you want to transfer your business internally to a manager, family member, co-owner, or staff member, a valuation is equally important. That’s because of the double taxation inherent in these transfers.
An insider probably doesn’t have deep pockets, and they get their income from the business. So they pay income tax on the money they receive from the business, then purchase the business and you must pay capital gains plus net investment income tax. When the IRS gets more than 50% of the available cash flow, it’s hard for any investment to succeed.
A better option is to value your interest at the lowest value you can reasonably defend. Then make up the balance through direct payments from the company to you, since these payments will be fully deductible. This preserves your cash flow, increasing the probability that you will receive the cash you seek and that the business will thrive well into the future.
All Available Cash Flow is Yours
As long as you remain the owner, all available cash flow is yours. It doesn’t make much sense to use your own money to buy yourself out. If you plan for an internal transfer, consider that valuing at the lowest defensible value reduces tax burden. Most direct payments will come to you after your exit. So a well-articulated buy-back agreement it critical to a successful transfer if things go awry. Remember also that controlling interest is transferred only when your financial objectives are met.
Valuing your business now helps you plan for a better tomorrow. It can also offer insight about areas of weakness and strength, enabling you to build value over time. Eventually, that can mean a higher sale value, putting more money in your pocket if you plan to sell either to another business or a PE firm.