As we discussed last week, calculating your business value gap is an important step to take (and continue retaking periodically) if your ultimate plan is to sell your business. The value gap represents your company’s actual market value compared to your most successful competition. It can help you determine what potential buyers are actually willing to pay.
It is very common for a business owner to have a biased opinion of the worth of his or her company. You’ve invested a lot of time and money to build up the business. Unfortunately, blood, sweat and tears don’t always equate to real-world financial value. You may have an idea of what your company is worth, but in reality it doesn’t quite measure up the competition. Potential buyers will recognize this business value gap and it could hinder a potential sale.
So, now you have calculated your business gap and you know where you stand. You have a new goal of where you would like your company’s valuation to be by the time you are ready to sell. Let’s say your company is worth $1 million right now. However, you want it to be worth $5 million in five years when you plan to sell. How, can you bridge that business value gap over these next five years?
Of course, it is easier said than done. If you could magically make your company significantly more profitable or desirable for a potential buyer, you would have done it already. You have to do your research, rethink your business plan and do what it takes to increase your future business valuation. Valuation is not necessarily tied in only to profitability or amount of physical assets. It can be based on a variety of tangible and intangible factors that buyers are looking for. There is no one simple solution that bridges the value gap for every business owner.
Still, there are some strategic financial moves you can make that should help you narrow your business value gap. Here are some ideas to consider:
This is one of the most commonly used strategies. There are different types of seller financing, but the one we see most often is called an “earn-out.” This is a structured agreement between the buyer and seller. The buyer pays for the business upfront, but then gives the seller the opportunity to earn more capital. There are usually specific stipulations in place—milestones that must be met after the business sale is complete.
Essentially, seller financing methods like earn-outs are giving the seller a chance to prove that their company is worth what they think it is. If the company doesn’t live up to these expectations, the buyer has more options to get a better deal on the business.
As we said, there are many different factors that can affect a business valuation. It’s always good to perform a business valuation periodically (at least once a year) and calculate your current business value gap to know where you stand in the market. When the time comes to sell, you can re-valuate your business and make sure you are demonstrating the true worth of your business to the buyer. They may have only performed a basic valuation or are basing their information on less than the full picture. Show them the full picture, re-valuate your company thoroughly and give them a more comprehensive financial outlook that displays your business is truly worth what you say it is.
If stock in the business is valuable, the buyer can sell shares back to the seller. This allows the seller to retain a minority ownership stake in the business while the buyer assumes majority control without having paid full price. It can be a win-win solution that puts less risk on the buyer and leaves the seller at least somewhat involved in the ownership of the company. It can definitely help bridge the valuation gap. Rolled equity can also help cut down on tax consequences for the seller. It is very important to do your research on rolled equity to ensure you make smart selling decisions. Not all deals are created equally!
For help with a professional valuation of your business and calculating your business value gap—as well as creating a stronger business plan to bridge that gap—contact Illumination Wealth today!