Even if your business is not for sale, monitoring its market value can be incredibly helpful. This article describes six ways that understanding value over the life of a closely held business benefits shareholders, directors and managers.
1. Value Report Card
Like financial statements, an annual independent business valuation is a type of report card on company health. CEO’s can use this report card to educate, align and focus executive teams on maximizing enterprise value. Owners and boards of directors can use it to hold management accountable for value creation.
2. Equity Transaction Enabler
Having a business appraised periodically enables equity transactions. I am talking about buy-sell transactions between shareholders, redeeming stock of retiring owners, and buy-ins by managers, key employees, family, or investors, to name a few. Most experienced business attorneys will tell you that not agreeing on valuation is the #1 impediment to successfully completing these transactions. An independent business valuation is usually the fastest route to an agreement on value.
3. Shareholder Agreement Test
A business valuation can be used to test the composition of your shareholder buy-sell agreement from a valuation perspective. In our experience, there are as many faulty buy-sell agreements out there as there are good ones. By faulty I mean that the valuation terms are incorrect or ambiguous, or produce unfair share values, which ultimately leads to surprises, divisiveness, and disputes among shareholders. Also, all buy-sell agreements, regardless of how well-written, lose relevance over time and should be tested periodically. A valuation expert can identify potential problems and recommend solutions.
4. Versatile Planning Tool
A comprehensive valuation report can provide a solid foundation for strategic planning and a roadmap to increasing value. Shareholders can use periodic valuations for their own retirement planning, estate planning, buying life insurance, and maintaining appropriate liquidity for future buyouts. Without an accurate valuation, these planning activities involve a lot more guesswork.
5. Executive Education
The very act of going through a valuation process is educational for owners and leadership teams. They will see what information goes into the valuation and learn what factors are driving or detracting from business value. Experiencing the valuation process also prepares them for what will happen if the buy-sell agreement is triggered or if the company becomes involved in an acquisition.
You may be aware that ESOP companies are required by law to obtain an annual independent valuation of their shares. Companies that have stock option plans are required to have regular valuations for IRC 409A and financial reporting purposes. Companies that have executive teams whose compensation is tied to company value through the use of stock appreciation rights or phantom stock plans need valuations as well.
Getting This One Done!
An experienced business appraiser can usually recommend the appropriate scope of analysis and reporting for your intended use and circumstances after a brief phone call with you. In many cases, a full scope business valuation (appraisal) is necessary or strongly recommended. In other cases, a limited scope calculation of value may be sufficient. At issue are accuracy, the knowledge of intended users, credibility, compliance requirements and cost.
Working with the same valuation analyst (appraiser) over time has additional benefits. Your team gets to know and trust the valuation expert. The expert’s knowledge of the company and its industry grows, and they become better able to offer insights into improving business operations, financial results, enterprise value, sale readiness and marketability. Also, valuation updates are generally faster, less expensive and more consistent.
Al Statz is the founder and president of Exit Strategies Group, a leading lower middle market M&A advisory and business valuation firm. For further information on this topic or to discuss a potential business sale, merger or acquisition, confidentially, Al can be reached at 707-781-8580 or email@example.com.