Studies indicate that on average, the value of a business makes up 70-80 percent of an entrepreneur's total portfolio. However, most business owners don’t know how much their business is really worth. For the business owner nearing retirement, knowing the accurate value of their business is essential to completing a financial/wealth management plan. 

Financial advisors have the unique perspective on a business owners’ personal financial picture, but not necessarily an in-depth understanding of a company’s value. The entrepreneur’s business interests can be complex and difficult to work into a comprehensive financial plan.

This article will educate financial advisors on some red flags that a business owner/ client may face. Owners may be at risk of jeopardizing their retirement income by failing to plan their business exit.

How Much Is The Business Worth?

An owner’s business is often the most valuable asset that they own, as well as being the primary source of personal income. Managing a successful business requires a huge personal sacrifice, and growing the enterprise into a viable business can take decades. The choice to exit the company may be the most important professional decision an owner ever makes.

In order to make an informed decision about planning an exit, an owner needs to know the approximate value of their business. Assume, for example, that Mary owns Snowline Outdoor, a $15 million sporting goods manufacturer that specializes in hiking, biking and camping gear. Over the years, Mary has built Snowline into a well-respected brand name, and she has been able to differentiate her products from other manufacturers in the industry. Consider these factors that impact the valuation of Mary’s business:

• Valuation Expert: A valuation expert can provide the best estimate of the value of Mary’s business. The valuation will include an in-depth assessment of Snowline’s financial statements, and a comparison of Mary’s financial results with similar companies. The valuation can be a starting point for negotiating the sale of the business.

• State Of The Business Now: Why is Mary considering a business sale now? Does Snowline need more capital in order to grow? Is she concerned that she cannot keep her experienced management team in place? Does Snowline operate in a mature industry, one that makes growth difficult?

• Current Initiatives: What is Snowline doing right now to improve its financial results? Is there an opportunity to disrupt the industry? Can Snowline benefit from starting a new product line? Is there new technology that can help the company grow?

Each of these factors has an impact on the value of the business, and the timing of selling the business. If a client tells you that they’re considering a business sale, these issues need to be addressed.

Complex Legal Structure

Even if a business is attractive to a buyer, it may be difficult to sell, due to legal issues. If you’re aware of any of these situations, it may be difficult for your client to sell the company and invest the proceeds:

• Partnerships: If Mary and two other partners own Snowline, the three partners must be in agreement in order to smoothly transition the business to a new owner. Each partner may own a different percentage of the entity, and the capital invested may differ between each partner. Partners may disagree on the value of the business, or dispute the timing of the sale.

• Owner’s Divorce: A divorce proceeding can complicate the sales process for an owner. Assume that Mary owns the business with Bob, and that Bob is going through a divorce. Bob’s interest in the business may be considered a marital asset, which means that his spouse may have some rights over the value of the business asset.

• Contingencies: A contingency is a future event that cannot be predicted with certainty, and business contingencies can impact a company sale. Assume, for example, that Snowline has been sued for patent infringement, and the issue has not been resolved. This legal contingency may deter potential buyers from making an offer for Snowline. In addition, many companies have contracts with customers, employees and vendors. In order to sell the business, Snowline will need to rework these types of agreements.

All of these issues can impact the value of the business and a potential company sale.

No Succession Plan

Perhaps the biggest obstacle to a company sale is the lack of a business succession plan. No one wants to consider his or her own mortality, and this subject can be difficult for an owner to consider. However, every company has stakeholders who are concerned about the future viability of the business, including owners, creditors, company management, customers and vendors.

Every owner should decide who will manage the business if the owner dies or becomes disabled. Here are some other steps that can help the business stay viable if the owner is no longer involved:

• Buy-Sell Agreement: Mary can put a buy-sell agreement in place, which allows a designated party to purchase Snowline, based on a financial formula. This type of agreement minimizes business disruption if Mary cannot manage the business herself.

• Management Contracts: The value of a business may largely depend on smart decisions made by experienced managers. To keep valuable managers in place, and an owner can provide financial incentives to motivate managers to stay after a company sale.

• Audited Financial Statements: An owner should have an independent CPA firm perform an audit on the financial statements each year and issue an audit opinion. A potential buyer will have more confidence in audited financials statements, and this can speed up the due diligence process in the event of a sale.

These steps can help an owner plan for a business succession and speed up the process of a company sale. Having a succession plan in place also increases the value of the business.

How Much Cash Is Needed After Exit?

No owner wants to sell a business unless the price is reasonable. If your client is considering a business sale, help them start with the end result in mind. Consider their current financial status, including total assets invested. How much would a business sale need to generate for an owner to invest the proceeds and retire?

Say, for example, that Mary has $1,000,000 in invested assets. Her financial advisor determines that she would need to invest another $3,000,000 to generate her ideal retirement income. If Mary’s interest in the business can’t be sold for at least $3,000,000, she may decide against the sale and manage the business herself for several more years.

An Informed Seller

Selling a business can be an emotionally draining process, because the typical owner has invested years of work and sacrifice. To maximize the proceeds received for a sale, an owner must do his or her homework. Financial planners are in a unique position to help a business owner become fully informed. Use this discussion to help your clients prepare themselves for a possible business sale.

Dan Doran, CVA, is the founder and principal of Quantive Business Valuations, a certified valuation practice serving privately held businesses nationwide. He consults on hundreds of valuations each year, ranging from cases of divorce litigation or SBA 7(a) lending requirements to buy-sell agreements or purchase and sale proceedings.