Can You Retire When You Want To? The Truth About Valuing Your Business

 In Finance

Smart business owners will tell you it’s never too early to plan for life after running a practice. They’re right, but did you know that proper planning involves a firm understanding of your practice’s value?

What Is Business Value?

Business value is the tangible worth the business generates on the open market,”

said Haney, who offered three lenses through which business value can be examined:

  • Cultural, which speaks to the expertise and development of key staff members within the business. It’s essentially the human component, including who operates the business, how they operate the business, and the environment in which they’re doing it.
  • Operational, which reflects processes and systems. This pillar involves key performance indicators, analytics, benchmarks, goal setting, and tracking — core pieces that help drive business.
  • Financial, which provides a foundation not only for the present but for the future. “You can’t really have culture or operations,” said Haney, “without a solid financial base.”

How Is Business Value Measured?

Valuing a business involves two main methodologies: income-based and market-based. The different approaches can seem complicated, but Haney explained the basics:

Income-based approaches are less about the money you make and more about how much you keep at the end of the day. If you’re a $1 million, $2 million, $3 million practice, that’s obviously very good, but it’s really about how much money you keep or how efficient your operations are.”

Income-based methodologies involve two approaches:

  • Capitalization of earnings, or valuing your business based on what has happened in your business over the last three years. This approach involves owner discretionary earnings, or ODE.
  • Discounted cash flow, which values a business based on what could happen in the future — using a conservative outlook. If a practice grows at 5 to 10 percent net revenue each year, maintains a reasonable operating expense structure, and so on, what are those future cash flows worth now?

Market-based methodologies focus on:

  • Historical net revenue production, or how big a player you are from a net revenue standpoint. “The bigger you are,” noted Haney, “the higher multiple of your net revenue you can typically garner, because you have more say within the market.”
  • Private-pay-expenditure market share, which gauges your position as a dominant force. “How much of that market would a buyer actually get by purchasing your practice?” asked Haney. “If you’re at 25, 30, or 40 percent market share, you’ll get a higher multiple of your revenue than someone who’s at 5 percent, because the buyer is going to say, ‘I know that I can buy this 30 percent market share practice and be a dominant player from day one.’”

 

Why Does It Matter?

There’s nothing last-minute about successful retirement or business succession. It takes time, awareness, strategy, consistency, and persistence.

A lot of business owners are looking to exit their business in three, five, 10 years. The thing is, they have to start focusing on business value now.”

Consider:

  • A business is typically the first- or second-largest asset in an owner’s financial portfolio, so a large portion of your retirement could be dependent on the value you’re able to obtain from the business.
  • Understanding the principles of valuation — how value is positively, negatively, or otherwise affected by what you do every day in the practice — is vital to focusing on the levers that will increase that value.
  • Awareness and strategic action over time allow you to sell for top dollar when exiting the business through an equity earn-in, an equity buy-in, or an outright sale to another individual — and that’s what it comes down to.

Putting It All Together

How do you go about creating and extracting value? Tie it back to the cultural, operational, and financial profiles of your business, advised Haney. “It’s not just about increasing your revenues year over year over year but about doing it in a disciplined fashion.”

  • Have the right people in the right places at the right times doing the right things in order to have a strong culture to grow your business effectively.
  • Establish strong key performance indicators, with standardized processes and systems in place such that if something starts to go awry, you know how it should be operating and can get it back on track.
  • Be financially disciplined. Growing your market share, for example, isn’t just about market domination. It’s about the positive impact on the owners, the key employees looking to gain additional responsibilities or grow within their positions, and the overall value of the practice.

 

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