Our friend, Dan Doran of Quantive Valuations, provides business valuations for owners looking to sell, buy-sell agreements, estate planning, and 409(a) compensation. He wrote a great piece on planning for the future and how your business' value fits into your personal picture. Here ya go:
Gap Analysis: The Magic Number
We talk a lot about the concept of “gap analysis” – and rightfully so. You can’t really make a plan without knowing 1) where you are and 2) where you want to get to. Here we’re going to kill some trees talking about gap analysis in the context of exit planning.
First Things First
Let’s make a few assumptions.
- You own a business.
- You will eventually exit the business (This is fact. You WILL exit).
- You want to exit on the terms of your choosing.
- Most of your net worth is tied up in said business.
All pretty straight forward. After all, we’d be hard pressed to name a business owner we’ve met that DIDN’T want to control their destiny. But the fact of the matter is that transitioning out of a company is difficult. In order to truly exit on the terms of your choosing, it is imperative to put a careful plan in place to do so.
Two Tools in the Toolbox
When heading down this path, the starting point is getting a grip on two key data points: 1) What is your business worth today? 2) How much do you need, post-tax, to comfortably retire?
To understand these data points, you need to complete a certified appraisal, and work with a financial planner to develop an understanding of your retirement needs. Both of these items will cause you to reach into your pocket and pay for advice, yet this advice has an incredible ROI to it. We can run these numbers all day for you – but suffice it to say that the return on X-thousand dollars now for 1) a comfortable retirement, 2) increased enterprise value, and 3), peace of mind on knowing with certainty that you WILL be able to retire, equates to a really darn good investment.
A Quick Look at Gap Analysis
So you’ve decided to engage the services of your favorite valuation firm, and a trusted financial advisor. We are going to work the numbers, dive into the company, and come up with a value.
Turning the page, when you work with your financial advisor, we’ll add another data point to the chart. It looks like this: Magic Number here --- Current Value over here. Gap in the middle.
Putting a Plan in Place
With this information in place, it’s time to put thoughts into action. How are you going to achieve your goal valuation and close that gap? We can provide some insight and point you in the direction of the right folks to help. All in all, we can emphatically say that in the vast majority of cases, “the passage of time” is not a strategy that is going to help achieve your goals. It’s time to act.
The Gap is Wide: Increase Earnings and Mitigate Risks
Perhaps the number one driver of value is earnings. Increase earnings and you will increase your valuation. So start here in tackling your gap.
But let’s keep in mind the issue of risk mitigation. In the valuation world we often trot out a bell curve chart, pointing out that our goal is to figure out where your company exists on the curve. By addressing the factors that increase perceived risk to your firm, you can accelerate the positive impact that increased earnings have on value.
What if There is No Gap?
Easy. You are in the drivers seat. You can now make some key decisions as you approach the exit:
- Forego an earn-out (less overall value, more cash up front), and side-step messy post closing issues.
- Shorten the negotiations process at the deal table as you do not need to fight for every last dollar (making for a much less stressful transition).
- Fund projects that you feel strongly about, be they charitable, rewarding deserving employees, etc.
But the above still requires advanced planning. Working with a good financial advisor, you’ll understand that “at a value of $X, I have a 90% chance of fully funding my retirement.” This data is powerful when it comes to approaching your exit.
If you don’t work in advance to understand these two critical data points (value now and your “magic number”), you are really selling yourself short. It’s impossible to control the course of your exit from the company without really understanding these two data points – ideally well in advance of your chosen time to exit.