Three Questions for Succession

Baby boomers own around two-thirds of all privately held businesses in the US.  It is no secret that this generation is knocking on the door of the typical retirement age with many looking to transition their businesses and ride off into the sunset. The numbers are likely to be staggering over the next decade, with the potential transfer of wealth amounting to a number in the double digit trillions of dollars.  The transition of baby boomer businesses is something that should get more than a little bit of attention in the coming years.

Millions of employed wage-earning Americans meet regularly with financial advisors and planners to discuss their retirement goals.  These discussions can often be boiled down to three questions:

  1. What is my net worth today?business valuation and succession planning
  2. How much do I need for retirement?
  3. How do I make up the difference between #1 and #2?

Number one can be an easy question to answer for someone who gets a quarterly statement from their 401k provider.   Number two can be a bit more difficult, but can be determined with some assumptions and math.  Number three can be tricky, but generally relies on some combination of budgeting, asset allocation, and time.

What if your largest asset is not your retirement account, but your ownership interest in a privately-held small business?  This likely makes number one a bit more difficult to answer.  Without an answer to question number one, question number three is darn near impossible.  And question number three drives all the action and decision-making.  Luckily, there are valuators that can tackle the difficulty involved in answering number one when a large portion of wealth is tied up in a small privately-held business.

Early on in the succession planning process, it is often advisable to figure out where the business owner’s net worth stands:  The answer to number one.  A business valuation can help find that answer.  Many business owners don’t know what their business is worth and don’t think valuations are necessary.  Without a strong indication of what the business is currently worth, succession planning can become extremely challenging.

Once a qualified appraiser helps with the answer to number one, decisions can be made in response to question number three.  Programs and practices can be implemented to enhance the value of the business.  These programs usually focus on two main ideas, which are the main levers that drive the business’ value:

  • Increasing the earnings or cash flow of the business
  • Reducing risk

business valuation and succession planning

Plans to grow revenue, decrease production costs, or trim unnecessary administrative expenses can be put in place to increase cash flow.  Efforts to diversify the customer base, expand geographically, or reduce the reliance on a key-person can take some risk off the table.

When a business owner knows where they are now and where they need to go to in the future, decisions can be made to help make up the difference.  Business valuations can help spark the succession planning discussion and can result in significant value improvements for the business that the owner can realize upon exit.

Succession planning is often overlooked until it is too late.  Being proactive in succession planning, which likely means starting with a valuation, is imperative in order to ensure for a smooth transition for the business and financial security for the retiring owner.