It is estimated that approximately 60% of the small businesses in Canada today are owned by baby-boomers. Over the next 15 years these business will need to be transitioned to ownership. Estimates are that only 10 to 15% will be transferred successfully. The other 85 to 90% will die and leave room for new market entrants. These are not good odds if you are thinking that your current small business is material in funding your retirement.
Whether you are transferring, selling, adding or buying a business, at some point in time you will need to put a value on that business. Whether selling a business or gaining additional financing you will want to maximize the value of your business. If you are looking to buy, you want to make sure that the value of the business is sustainable over the long term.
The common theme between investors or lenders is the access to cash and more importantly, getting a return on that cash. As a seller or a borrower the common theme is the need for cash with minimal risk or cost attached. As a seller, buyer or investor common principles begin to emerge. That common principle is what is the best alternative to the considered deal that sits before them. It is good to know the Net Present Value (NPV) concept as deals are usually valued using NPV.
NPV is simple and works well when considering dissimilar options such as buying a business or investing in secure (almost) risk free government bonds. As investments become more risky, the return expected goes up as well. So bonds may trade at 8% yield, however riskier investments would be expected to return 15% or even 25% to compensate for unknowns. The effects of risk and increased expected return rates mean that the NPV value will decrease. Basically this means a $1.00 per year (over 5 years) returned at 5% will be worth $4.33 versus the $3.35 a 15% yield will return in today’s dollars. Lesson learned: the risky your business the less the NPV will be and hence the less you get for your business or can borrow for your business.
There are many factors that go into measuring the riskiness of your business:
Other items such as:
Many things can be done to minimize risk and maximize the value of your company.
The first 2 to 3 items can be well managed with a good accountant at your disposal. The last 5 items require you to work “on your business” not “in your business”. For owners, this is very tough as it means letting go and making tough calls sometimes.
If there were one piece of advice I would like to offer above more than anything else it would be to start early. These issues cannot be resolved a month before you sell or gain financing. Any thorough analysis would show that you’re putting on a facade. Start early and let the culture of your organization yield the results required.
I guess the title should have read “9 things to do to help maximize the value of your business”.
RK Fischer & Associates