As you’ve probably learned from us over the years, successful succession planning for LBM business owners starts with obtaining an unbiased, third-party business valuation. When it comes to determining the value of your LBM business, being aware of the expectations before beginning the valuation engagement will provide you with a clearer understanding of the valuation process. Here’s a breakdown of what you should expect:
Objectivity is key
When assessing the value of your business, objectivity is imperative. Your business valuation must be able to stand up to the scrutiny of potential buyers and regulatory bodies like the IRS. An objective valuation ensures fairness and credibility, providing a solid foundation for negotiations and legal compliance. When potential buyers or regulatory authorities examine your valuation, they should find a transparent and unbiased report that accurately determines the value of your business.
Focus on the future
While historical documents provide the valuation analyst important information about your business in the past, a proper valuation must go beyond and look into the future. Valuators analyze your historical data to understand your business’ growth trajectory and the sustainability of your earnings. However, the real value to a potential buyer lies in the expected sustainable future cash flows. Even if the valuation date is set for a specific point in the past, the valuator must project forward, considering factors such as the impact of future receivables, expenses, and how growth will be financed. This forward-thinking approach ensures that the valuation captures the value of your business to a potential buyer.
Collaboration is a requirement
Be prepared to invest time in gathering documents and answering questions. The valuator’s first task is to perform due diligence as if they were a potential buyer. Due diligence requires a thorough analysis of your business, which includes your legal incorporation and governing documents, financial statements, customer and vendor lists, contracts, and projections. This thorough analysis aims to identify potential issues that might arise during a sale. By addressing any concerns during the valuation process, the valuator’s goal is to make the business more marketable for a future sale.
Discuss the engagement parameters
Because valuations are forward-looking, it is important to understand that the valuator will need to set specific parameters. Without these parameters, the valuation process becomes challenging due to the numerous hypothetical scenarios that could be considered. As the owner, knowing these parameters (summarized below) can help both you and the valuation analyst communicate effectively.
Purpose of the Valuation: Clearly define the reason for the valuation. Is it for a potential sale to a third party, internal gift or transfer, estate purposes, or other strategic decisions related to the business? Determining the purpose of the valuation is the foundation of a defensible conclusion of value.
Type of Value: Depending on the purpose of the valuation, the valuation analyst will determine whether to calculate Equity Value or Enterprise Value. For example, Equity Value is used when a gift is made to a family member. Enterprise Value is used when selling your business to a competitor or financial buyer.
Date of the Valuation: While this may not seem important, it is a vital component to a defensible valuation. Without a valuation date, there are too many hypotheticals to conclusively determine a value for your business. Therefore, we recommend that the valuation date be the most recent month, or quarter end, or end of the month immediately preceding a trigger event (e.g., death, retirement, etc.).
Discounts: Understanding the applicable discounts, and when they are applied, is directly related to the purpose of the valuation. For example, if we are gifting a minority interest to a child, then we can apply discounts for lack of control and lack of marketability. These discounts lower the value of the business and allow the owner(s) to gift more of the business without exceeding the lifetime gift exemption. Conversely, if we are selling to a competitor, we do not want to apply discounts because we are negotiating for the highest selling price.
To summarize, a successful valuation for LBM dealers requires more than number crunching. It requires objectivity, a forward-looking approach, and a collaborative effort between you and the valuator to ensure that the process not only withstands external scrutiny but also adds relevant information for strategic transition planning.
