Estate Planning

Why It’s Important to Understand What Your Business is Worth

You see it on Shark Tank all the time. People will say they’re looking to sell a 10 percent stake in their business for $250,000. In essence, they’re valuing their business at $2.5 million, but they have no sales. Without revenue, these businesses aren’t worth anything at all, and how often do the entrepreneurs on Shark Tank get a counter offer from one of the “sharks” for 100 percent of the business for a far lower number?

Without having a solid understanding of the value of your business, you may be setting yourself up for trouble. This can put you in a difficult position when it comes time to sell the business, borrow money, pass it on to your heirs, or even make everyday decisions about how to grow.

I’ve been working with business owners for nearly 34 years, and I’ve learned that people often overstate or even understate what their business is really worth. Usually they’ve never completed a rigorous valuation, so they fall back on guessing. People are often very good at what they do in their business, but that doesn’t make them an expert at accounting or business valuation.

Or, perhaps they just feel like bragging that their company is worth $10 million when it’s really only worth $1 million, but that won’t really work when it comes time to seek a business loan or bring on a junior partner. I’ve seen others understate the value of their business “for estate planning purposes,” but that seldom works to anyone’s benefit since it is hard to build a solid plan around bad numbers. The IRS will want its fair share, too, and an unrealistic low-ball valuation of a business is likely to trigger an audit. You need a solid, defensible and realistic valuation.

An example of how ignorance of the true value of the business can hurt you comes from one business owner I work with who wanted to know what his company was worth. He was in the middle of a reinvestment program, which can be a good thing when it’s part of a deliberate strategy to grow the business for the long-term. However, in the short term such spending impacts the cash flow, one of the key factors that determines business value. Rather than building up the value of his business, his reinvestment program was hurting it. He and his wife were shocked that the business wasn’t worth as much as they thought it should be. With a bit of strategic counseling on cash flow management, he is now working to wind down the buying program so we can later revisit the business valuation and show him how much that change can actually help increase its value.

Of course, it’s not easy to undertake a business valuation. Using the traditional approach can take a long time, often four weeks or more. It can also be expensive. Finally, and perhaps most importantly, it’s intrusive, with the valuator combing through your books and questioning your accountants.

BizEquity offers an online tool that enables business owners to get a prompt, comprehensive business valuation. I’ve become something of an evangelist for BizEquity, working with other financial professionals and many of my colleagues in estate law and accounting firms to tell people about it. 

The fact is you should take the time to get a realistic idea of your business’s value. It’s likely your largest asset and, if nothing else, it produces revenue for you and your family. It may also be a big part of your retirement plan. Whether you plan on selling it or not, you need to know what direction your business is going.

This post is for informational purposes only and should not be considered as specific financial, legal or tax advice. Depending on your individual circumstances, the strategies discussed in this presentation may not be appropriate for your situation. The information in this material is not intended as tax or legal advice. Always consult your legal or tax professionals for specific information regarding your individual situation.

All opinions expressed in this post are solely those of the author and do not necessarily reflect the opinions of Penn Mutual, its affiliates or employees.

Penn Mutual and its financial professionals do not represent or endorse the accuracy or reliability of any advice, opinion, statement or any other information displayed or distributed through Biz Equity. Penn Mutual and Biz Equity are unaffiliated. Trademarks belong to their respective owners.

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