In order to leave your business successfully, you must not only know what you want (when you want to leave, how much money you will need and who you want to sell to) you must know how much your business is worth. For example, if you told your advisors all about your objectives but you couldn’t tell them with any certainty what your company was worth, how could they help you reach your destination? It would be similar requesting a map but not knowing if you planned to take a plane, a boat, a car or walk to the destination.
Knowing the value of your business is critical no matter who you plan to sell or transfer to. The primary three exit paths are:
1. Transfer your company to a family member
2. Sell the business to one or more key employees or co-owner(s)
3. Sell to an outside third party
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A Decision Framework
If you contemplate transferring your business to an insider (employees, children or co-owner) and you want to get paid the value of your business, then, generally speaking, the value of your business cannot exceed four times the true cash flow of the business (as illustrated in the previous issue of The Exit Planning Review™). We have defined true cash flow as the amount of pre-tax money distributed to owners via salary, bonus, distributions from the company such as S-distributions, and rental payments in excess of fair market rental value of the equipment or building used in the business. Let’s look at how cash flow determines the sale price to insiders.