The Old Way vs The New Way Approach to Business Wealth Transfers
IN YOUR BUSINESS SUCCESSION WHAT DO YOU WANT FOR YOU BUSINESS?
In owner’s decision to hold his business, longer term, does owner expect their business wealth is managed?
The business succession component, and the approach to transfer of wealth appear simple in their benefit, and the opportunity for both legal, tax and financial advisors and clients, alike. Yet a new “norm” has been established by business families as that they expect their wealth to be managed. This apparent shift requires legal, tax, financial advisors and service providers to change their behaviors.
We agree with this change, and we want the 10% of those who get it, as they see the new roles brought about by the new “norm”.
Historically service providers have valuation people on board. The challenge is which model are you practicing?
Valuation: The Old Way is fees as an expense and services as a commodity.
The planning is performed by the valuator. A business is a difficult to value asset(s) held but then the goal is to keep these costs down to alleviate expense yet also be the client’s hero. The resulting report focuses on equity value and fees as work products with nominal differentiation. This creates the “service as an expense mindset. Lastly the focus here tends to be on earnings generation and tax minimization.
Valuation: The New Way is fees as an investment and services as an annuity that aligns the client and advisors’ goals.
This sets the client’s expectation earlier in the process to identify how the bylaws and trust agreement provisions for the business influence risk, discounts, and value.
The valuation fees should be incorporated in the planning book and invest in trusted advisors who can achieve high ROI for clients, as asset values increase from their collective efforts. The resulting of the valuation firm can be to assist in investment policy draft (address 2036 issues) and provide an invaluable service; identification of risks/value drivers that enhance both or either of discounts or values.
The focus is on mitigating risk and evaluating multiples in the longer term. And, to enhance transfers with higher discounts in the short term. Lastly another focus is on family dynamics causes, not just symptoms.
What a Typical Scenario May Look Like
A $20million annual sales plastic manufacturer with a 62- year- old owner with 3 kids, and one is working in the business. A traditional Old Way valuation is $4.5million.
Findings
Balance sheet findings reveal mediocre cash, inventory and A/R management with nominal capital and no debt.
The P/L story shows EBITDA declined from 11% to 4% in the past five years, despite 50% to 10% year-over-year revenue growth.
From their financials: elevated repair and maintenance, low advertising, high officer compensation, labor, and occupancy expenses.
Third party data suggests poor to moderate performance, the need to review agreements, management metrics and culture.
Non-financial statement risks included absence of process and procedures, nominal use of advisors, no forecasting/budgeting, no risk shifting with lenders, vendor, and employee risk concentration.
Results
Focusing on risks caused multiples to rise from 4x to 6x. EBDITA increased to 12% in two years and sales climbed to $25million. A new valuation climbed to $18 million, a four-fold increase.
The costs of services of advisors increase from 50% to 300% of billings. Original billings of $100,000 rose to $300,000. Net increase in value $18-$4.5million-$100,000 =67.5 ROI. Every dollar invested provides $76.50 returned.
Enhanced access to an annuity versus a transactional deal flow from the collaborative team (attorneys, accountants, bankers, PE, insurance, wealth, and business advisors. The question is how broad is YOUR Book of Knowledge and Cost of Investment?
My thanks to Carl Sheeler PhD, ASA, CBA, CVA for this content for a lower-mid market case. Yet the issues and challenges apply to larger businesses too.
Where is your business positioned now?
