Whether you intend to sell your business to a third party or keep it in the family, understanding the value of your business is an important aspect of succession planning.
Active Knowledge Question:
What do you think your business is worth and why?
We often think of the value of our business in terms of share price or what we think someone will pay for it. But these approaches can often misdirect your efforts in building the real drivers of the capital value of your business.
We tend to estimate the capital value of our business in a number of ways and these approaches are often adopted in succession planning to determine a fair value for a business, for example:
- Independent Valuation: Being the sum attributed to the value of a business based on a capitalisation of profits or discounted cash flow model, usually by a professional valuer such as an accountant.
- Listed Company Share Price: Many larger family businesses are listed on an exchange and, therefore, have a market share price. But if the family controls a material interest, the shares may not be readily traded and, therefore, the price may not be a fair representation.
- Market Price: The actual cheque that someone is willing to write, and have you bank, which will turn heavily upon the upside the buyer sees, the urgency of the sale, and the negotiation skills of the parties.
In each of these views of value, the sum is premised around historical profits and whether they will continue into the future. In each of these instances the value may not be suitable for succession, and is unlikely to direct your focus to the capital value drivers in your business.
We will look at capital value drivers next week but let’s consider the suitability of a valuation. The question to answer this point is simply, why are you seeking to value the business? In succession it can be, for example:
- To guide what you could expect if the business was sold to a third party.
- As a basis for selling the business to family members.
- As a basis for allocating wealth across the next generation.
In succession, care must be taken in simply relying on a ‘valuation’ to determine a fair price. Succession requires any ‘fair price’ be considered in the wider context of the goals of your succession process to ensure it supports and does not undermine the goals of your succession. For example:
- A third party may discount the value due to lack of leadership continuity.
- A family member may debt leverage a business to pay the value and undermine its future viability.
- In allocating wealth, business values are often discounted to reward family members willing to step up and continue the business.
In succession, the context of the valuation must always be weighed carefully to achieve the right goals.
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All the best in the success of your business,
Richard Shrapnel
