Consider a Business Valuation. As you work toward your business value goals.

Chia-Li Chien | Sept. 29, 2011

Have you considered a business valuation? Many business owners have a business valuation for various reasons. For the most part, they use the valuation report for the purpose of attracting investors, getting loans, due to a partner separation or divorce, or simply getting the right insurance coverage. No matter what the reason, a valuation is a good idea.

John and Mary (not their real names) are in the process of internally transferring their business to their son David (not his real name) in the next seven to nine years. During this internal transfer planning stage, I asked a business valuation company to perform a formal valuation for their business. In one of the routine valuation Q&A sessions, John and Mary were asked thirteen different questions about their 15-year construction business. All thirteen questions address “what impacts business value.” These thirteen valuation questions fall into three broad categories:

A. Increase recast EBITDA
B. Reduce risk
C. Employ additional high yield capital

Remember, what buyers or investors are looking for is to increase their ROI (return on investment) and reduce their investment risk. If you can demonstrate those two items, then they will view your business as a good match for their investment dollars.

Your answers to the valuation questions help determine the final formula of the current business fair market value. Of course, it will contain any discounts, etc. based on the current IRS guidelines for internal transfer planning purposes. I thought I would share these questions with you here, so that as you build value in your business, you know what buyers or investors are looking for.

I’ve listed the questions John and Mary answered in each category:

A. INCREASE RECAST EBITDA

Question #1 – What is the reason your revenue experienced declined in year 2008?
Question #2 – What is the plan to increase revenue for the next three years?
Question #5 – How do you ensure your operating expense remains efficient to remain above industry profit margin averages?
Question 6 – What’s your internal process to help sustain above-average profit margins?
Question #12 – Are you paying market rate for rent?
Question #13 – What figure do you expect on non-recurring expenses for the next 3 to 5 years?

B. REDUCE RISK

Question #3 – What percentage of the current client base is in service? What percentage represents future contracts?
Question #4 – What is the current client retention ratio?
Question #7 – What is the cost to replace both owners (John and Mary), as we determine if it is critical to have John in the business?
Question #9 – If john is no longer in the business, what is the current structure to support this loss?
Question #14 – What is the biggest business challenge you face today? (i.e. finding new clients, finding key managers, industry regulations, increased need for technical skills, etc.)

C. EMPLOY ADDITIONAL HIGH YIELD CAPITAL

Question #8 – What does your consistent marketing and sales system look like?
Question #10 – What is your current products offering structure? (From different types of revenue stream perspective.)
Question #11 – What do you expect in capital spending for the next 3 to 5 years?

Perhaps because they have had me on their team for quite sometimes now, John and Mary were able to provide very satisfactory answers to all 13 questions. And since we’ve been consciously building John and Mary’s company in term of value, none these 13 questions came as a surprise. John and Mary answered them exactly as the valuation expert expected in support of her initial paper assessments. This will help John and Mary receive a desirable business valuation report that will not only support their goal to internally transfer but also to support a willing buyer on the market. Their exit goal is to gift a portion big enough for their son David to eventually obtain a bank loan to buy the remaining shares. This way, John and Mary will accomplish their goal of not just simply giving the business to David for FREE. David will also have some skin in the game.

You must consciously grow your business in value in terms of the three broad categories, which impact your business value. Let me quickly review the three broad categories again:

A. Increase recast EBITDA
B. Reduce risk
C. Employ additional high yield capital