The Importance of Valuation in Business Planning
By Michael P. Weiner, Esq.

Different business owners contemplating growth or liquidity events approach
these significant “bet the company” decisions in different ways.

Business growth may come via the addition of a “working partner,” or the
providing of growth capital by a strategic or financial investor. Liquidity may come
through a gradual succession plan involving transfers of equity interests to
current senior management, or, in the case of a family business, secondgeneration
participants. Liquidity also may come through an outright sale of the
business.

Assuming that the business owners have, for whatever reason, concluded that
the time is right to implement a structured plan to grow the enterprise through the
introduction of additional human and/or financial resources, or that the time has
come to sell or otherwise exit the business, one question must be the starting
point for any analysis of the various options available to accomplish either of
those objectives: What is the business worth?

Attorneys are not typically trained as valuation professionals. However, we
frequently assist clients in the structuring of alternate methodologies for
accomplishing a specific goal, where the value of the underlying business is the
cornerstone of the planning process. A thorough, defensible appraisal of the
business by a qualified valuation specialist is a critical component of such
planning.

Let’s look at some examples.

A business owner who has historically been the sole equity holder now wishes to
“share the load” by accepting a co-owner, or “partner.” The intent is for the owner
to continue to maintain a substantial, often a majority, ownership interest in the
business, but for the partner to take on some of the managerial and operational
burdens which the owner has been carrying since the inception of the business.
So, the owner begins to think about how the prospective partner, who may be an
existing management employee, a family member, or a previously unaffiliated
third party who the owner believes would add real value to the business, may
“buy in” to the business.

How does the business owner go about structuring the prospective partner’s
equity interest in the business so that it provides a long-term incentive for the
new partner to join and remain in the business, provides some measure of
liquidity to the business owner, and at the same time, provides some assurance
to the business owner that this event will help grow the overall value of the
business?

An alternative scenario may involve a strategic (perhaps a vendor or customer)
or financial (perhaps an angel or venture capitalist ) investor interested in
contributing capital in exchange for an equity interest (most likely a minority
interest) in the company. In many circumstances, this will be the first time the
business owner has even contemplated sharing ownership of his or her
enterprise with anyone, not to mention sharing decision-making responsibility
and authority.

Yet another possibility is a calculated decision by the business owner to seek a
buyer for the entire business, to allow the owner to withdraw from the business
completely. In other circumstances, a business owner not actively seeking a
buyer may receive an unsolicited offer to buy the business, requiring the owner to
contemplate, again perhaps for the first time, the possibility of relinquishing
ownership and control over the business that he or she created.

The facts in each example differ, but in each case, an analysis of the viability of
each possibility starts with the same question: What is the business worth? In the
case of the “buy in” by the prospective partner, assuming that the business
owner does not intend to relinquish a majority interest in the business, how does
the owner establish a value for a minority interest in the business until he or she
knows how much the entire business is worth? Once that value has been
determined, is the prospective partner able to afford the “buy in” price based
upon his or her anticipated salary and profit participation while also maintaining
an acceptable standard of living?

In the case of a third-party investment, or a sale of the business, how does the
business owner even begin to evaluate whether the proposed transaction is a
“good” deal unless and until he or she has a thorough understanding of the
fundamental value of the underlying business? Three results are possible in such
situations: first, the business owner may lose a viable transaction by arbitrarily
setting a price threshold which is unrealistically high; the business owner may
“leave money on the table” by undervaluing the business; or the business owner
may be fortunate enough to strike a deal which captures the realistic value of his
or her business. I would respectfully suggest, at least in my experience, that the
first two results are seen far more frequently than the third.

So, what is a business owner to do? First, engage a qualified valuation specialist
to perform an appraisal periodically. Yes, the preparation of a thorough and
defensible appraisal every few years, whether conducted by a CPA or other
qualified valuation specialist, does cost money. However, the business owner
may be doing himself or herself a serious disservice by entering into negotiations
in any of the transactions described in this article without this baseline data. If the
information provided by an appraisal allows the business owner to avoid fruitless
discussions which would otherwise consume time and resources that would be
best applied to the underlying business, the owner has benefited. If the
information enables the business owner to command a higher price than might
otherwise be the case, the business owner has benefited.

The overall benefit of having a clear picture of the value of one’s business at any
particular time will be the ability of the owner and his or her professional advisers
to quickly and efficiently address fundamental issues about the ultimate
disposition of the business, in much the same fashion as the owner would expect
to conduct the day-to-day operations of the enterprise.

Copyright © 2005 Pepper Hamilton LLP. Used by Permission

If you would like to learn more about how Harbourton Group can help you
develop a strategic plan to maximize the value of your company prior to your exit,
feel free to contact Craig Allsopp at 609-466-3100 .

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