This two-part series is going to cover a subject often lost or ignored in financial planning – understanding the value of your equity. The fact is, most people don’t plan at all with their taxes or money and those that do often underestimate what could be their most valuable asset. Business owners look at retirement accounts, real estate or investments but either ignore or don’t know the value of their company. Most business owners are using their companies to achieve short term goals (i.e. paycheck, health insurance benefits, write-offs, etc.), however, the most valuable long term asset in their portfolio may be their equity in their company and this should be given consideration during financial and succession planning.
This article – Part I – will address the equity held by business owners or founders. In the next article we will cover equity held by employees through restricted stock arrangements or stock option grants. You can catch Part II, Plan for Your Equity – Employees here.
What is your business worth? If you have recently raised capital or brought on investors you may know the answer to this question. For instance, if you just raised $1,000,000 and in exchange you gave investors 20% of the business, then your company is valued at $5,000,000. What if you haven’t raised capital and maybe don’t even plan to? What if you are a self-employed person just starting out? Here are steps to consider while finding your business worth:
1. How are businesses valued in my industry?
This is an important first question as different industries value businesses in different ways. For example, your business may be valued as a multiple of gross revenue, it may be valued as a multiple of earnings, or it may also be valued based upon your intangibles assets (software, patents, etc.). Start researching now.
2. How do I increase the value of my business?
Once you know the answer to the first question this one becomes easier to quantify. If gross revenue drives the value – you need to increase revenue. If earnings drive the number – you need to increase revenue and refine your processes to increase profits. You get the picture… it’s not as simple as illustrated here but answering question number 1 will give you the ammunition to start here. Another way to ask this question is, “Who are potential buyers and what do they care about?”
From there you need create an internal structure that promotes increasing this value – and it starts with the owner. Hold yourself and your employees accountable to being better in the process of increasing value. Customers/clients must experience and feel this improvement first. A plan to increase value with lost focus on “who pays the bills” will fail.
3. How do I “plan” with my equity?
Planning your equity depends upon your goals. Do you want to leverage your business to retire by selling it down the road? Do you want to pass the business down to your children or a key employee? Do you want to create an income stream that lasts even into retirement?
Start asking yourself these important questions now. It’s very easy to get caught up running the business and have no real clarity on what it’s worth or how to properly leverage it to meet your personal goals – either today or in retirement. Too many people only view their business as a monthly paycheck and not as a valuable asset that can be far more valuable if properly understood.
Last, be honest with yourself about the value and take emotion out of it. It might be “your baby” but nobody else cares how much effort and energy you’ve devoted to building it. They only care about what it’s really worth today.