finance and investment

Importance of knowing what your business is worth

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There’s one question many business owners should ask themselves: “What is the true value of my business?” 

Your business may be your most valuable asset. When you know what your business is worth, you have a more realistic perspective from which to plan its future direction, as well as the future income needs of you and your family. Once you know the value, you can put in place more effective plans and strategies for future growth, business continuation, succession planning, and retirement planning.

According to the 2015 MassMutual Business Owner Perspective Study, just over half of business owners say they have had their businesses valued in the last three years.

A proper business valuation is not a “rule of thumb” or a figure agreed to with a handshake; it’s thoughtfully crafted by a credentialed appraiser after thorough research and is documented in writing. Be sure that any firm or individual you hire to value your business has the proper credentials, such as: Certified Valuation Analyst (CVA), Accredited Senior Appraiser (ASA), or Accredited in Business Valuation (ABV).

There are different ways to value a business, and the purpose of the valuation will dictate the method that is most appropriate. Here are a few of the more common methods:

•Book Value equals the value of a business’s total assets minus its intangible assets (such as goodwill) minus liabilities. Credentialed valuation firms can include intangible assets, such as goodwill, in the valuation to provide a business owner with a truer sense of the total value.

•Capitalized Earnings Value takes into account future cash flows and earnings growth in determining the total value of a company.

•Fair Market Value is the value based on what a knowledgeable, willing and unpressured buyer would pay to a knowledgeable, willing and unpressured seller in the market.

•Liquidation Value is what one may expect to receive for the business if the assets must be sold quickly to satisfy debts and creditors. This figure is derived by applying a discount to the value of outstanding accounts receivables, inventory, and depreciable assets.

Business continuation

Knowing the value of your business is an important first step toward building a sound business continuation plan to keep it viable, and your loved ones protected, following the unexpected loss of an owner. It helps you and your business partners adequately fund a buy-sell agreement equal to the current value of the business, and it allows you to develop a personal protection plan to help replace lost value to the family following the death or disability of the owner.

Retirement planning

There are many sound business reasons for knowing what your business is worth, but there are also personal ones. If your business is a key component of your retirement income strategy, then having an accurate picture of its value is critical. You’ve no doubt worked hard to build your business and one day you’ll look to enjoy the fruits of your labor in retirement. But what if the value of your business is less than what you think it is?

According to the MassMutual Business Owner Perspective Study, many business owners haven’t given the idea of when they plan on retiring much thought. However, what they did tell us is how they plan on funding that retirement when the time comes. Roughly 40 percent of business owners have no retirement assets outside of the businesses. These business owners will be heavily reliant on their businesses in some capacity to fund their retirements — either using proceeds from the sale of the business or continuing to receive income from the business post-retirement.

When estimating your retirement, you need to consider all benefits the business is funding — health insurance, life and disability insurance, entertainment and meals, etc. — not just your salary. This total amount equals the income replacement value of the business. If your goal is to maintain your current style of living after exiting the business, knowing the true value of the business will help you understand if there is a discrepancy between the income replacement value and the family’s retirement income needs.

Estate planning

The Federal Estate Tax exemption has helped make estate taxes less of an issue for many business owners. However, if you underestimate the value of your business, other serious issues can arise. If something unexpected happens to you — or your business partner — would you or your family be prepared to address any potential tax liabilities created by your business?

Eliminating the ‘Value Gap’

At some point, everyone exits their business, either by design or by default. So when you exit your business either at death, disability, or retirement, think about what value will be used:

•what you think it’s worth

•what the family needs it to be worth to maintain their standard of living

•the forced liquidation value.

The common discrepancy between these numbers can create a “Value Gap” — the gap between what you and your loved ones need the business to be worth and what it is actually worth based on the manner in which you exit the business.

The good news is that proper planning can help reduce potential value gaps created by an owner’s over- or under- estimation of the business’s value. For example, having assets outside the business, such as qualified retirement plans and other investments, can help reduce the value gap between what you think the business is worth and the income replacement value. In addition, products such as life insurance and disability income insurance can help address the value gap created if a business goes into forced liquidation following the death or disability of an owner.

By knowing what your business is worth, you can help protect the business and help ensure that you and your loved ones receive its full value.

Courageous decision is a good decision

Business planning is not something that’s done overnight, but having an understanding of the true value of your business is a smart first step toward helping set your business on the road to a more financially secure future.

Bruce Wernick, principal at Wernick Planning and Advisory, provides business succession and estate planning solutions for the individual and business owner. He is also affiliated with MassMutual Metro New York. For more information on this topic or other business strategies, you can contact him via email at bwernick@financialguide.com or 646-473-4199.