By some estimates, roughly 80% of typical small business owners net worth is tied up in their company. Yet, according to experts, most entrepreneurs have not taken the time to formally value their businesses.
“The value is the amount your business would be worth if you were to sell it to a third party,” says Mark Tepper, the president of Strategic Wealth Partners in Seven Hills, Ohio. Tepper, who specializes in working with small business owners, has devised a multi-step process for doing back-of-the-envelope valuations for his clients.
“We put the valuations together as part of our wealth management package,” he says.
Given that certified valuations cost between $5,000 and $20,000, Tepper says, many of his clients prefer to use his process at first before making the larger investment. Although he warns that his line of questioning offers only a rough number, he says it can still give clients a preliminary way of thinking about their assets' value. “These are not certified valuations,” he cautions. “You can’t take these to IRS court and challenge a gift tax or estate tax ruling. But we can turn [them]into a certified valuation in roughly a week’s time” if necessary, he adds.
As part of the process, he says, he asks his clients the following eight questions:
1. Can the company stand on its own two feet and operate independently of the owner?
“A good litmus test is if you don’t have the ability to take a month-long vacation from the business, and shut down email and phone communication for that month, then the business is not independent of you,” according to Tepper. “No acquiring buyer is interested in buying a job. They want to buy an investment.”
2. Does the company have a stable and motivated management team?
“Those are really the biggest assets in an acquisition,” Tepper says. “We want to make sure [the management team] will stick around post sale." To ensure this happens, he says, owners should have some sort of non-qualified deferred compensation in place: Valuable team members "should want to continue working so that their account will vest every single year,” he explains.
3. Are there operating systems in place that can improve the sustainability of cash flows?
To make sure a company is a well-oiled machine, Tepper says, there should be a how-to manual -- so that when somebody acquires the venture, they don’t have to learn everything from scratch. “This also helps to protects you when employees leave,” he says, “even if it’s just a receptionist.”
4. Is there a diversified customer base?
“You don’t want to generate 70% of your revenues from one big company,” he says, “because if they leave, you are out of business.”
5. Are there recurring revenues?
“The greater percentage of your revenues that are recurring, the greater the multiple that you will attract” when selling the firm, Tepper says. Firms are typically sold as a multiple of revenues, such as 10 times earnings or total revenues. “This would be something like a cell phone contract,” he says, “not like buying toothpaste. You want sales on a subscription or contractual basis. The acquiring owner would expect those revenues to continue.”
6. Are the financial statements easy to understand?
Buyers want to make sure your client is not running a lot of lifestyle expenses -- such as cars, vacations or country club memberships -- through the company. Those would make the company’s tax profile look better than it is in reality, Tepper says.
7. Is the appearance of the facility consistent with the asking price?
There can’t be broken windows or unkempt grounds at $10 million asking price, Tepper says.
8. Is the cash flow not only good, but improving?
A buyer wants to know he is getting an asset that promises to increase in value, he adds.