Buying or Selling a business? Better Not Until You Watch this Video

Welcome back to another episode of We're Talking Money. I'm Dustin Hocken, and today we have a great show for you. We're joined by Phil Clark, president and CEO of OmniStar Financial Group. Phil's been in the financial planning industry for over 30 years, and he's seen it all.

Many of our clients are business owners, and just over this past month we've had numerous conversations with them about business valuations. So everything that makes up business valuations, from what data, what challenges, what it's used for, and lots of other conversations. I thought it would be very interesting to discuss the basics of business valuations with Phil.

Thanks for hosting this show, Dustin. I love talking valuation. Excited to be here with you today, and hope we can deliver something that will be helpful to all of our listeners.

Thank you. Before I begin, please subscribe to our YouTube channel. It helps us continue to grow our reach. It helps you make better financial decisions. We're putting out interesting and relevant videos every week, so it helps you stay better informed. Click on the Subscribe button below.

Let's start with the basics. What is a business valuation, and what is it commonly used for?

Business valuations, so important. They're really important for a seller of a business, but they're also important for the buyer. If the two parties don't have a quality valuation, someone probably is going to get a short end of the stick. The valuation helps level the playing field. We know what the business is worth, and we know what someone should or shouldn't pay for that business.

And it also helps from a banker standpoint. If you're financing a business, the banker is going to want a valuation. Otherwise they're not going to be comfortable making a loan to whoever that buyer happens to be.

So you mentioned one reason why it's so important to have a correct valuation, for the bank and if they're trying to get funding. But what are some other reasons why it's so important to have a correct valuation on your business?

Probably the most important is the seller has been building this business, and this business is likely part of their net worth that is being viewed as something that's going to fulfill their retirement planning. And so if they don't get the right valuation, Dustin, they leave money on the table potentially, and we've seen that happen many times. They make a paper napkin kind of deal at the bar with their potential buyer before they go through a valuation.

What we see is they have this business that's generated income for them throughout their life. They're hopefully setting up retirement plans, 401ks, SIMPLE IRAs, through those businesses to fund retirement. But their plan is, it's imperative for their success that they get this windfall when they sell their business. So you're right, it's so important that the valuations are correct, and they often miss that.

Either they don't get a qualified valuation expert, or they try to do it themselves based on what they think the business is worth, or maybe a friend has sold a similar kind of business. As you know, we work with so many in the medical profession, and sometimes they'll just talk to a buddy, and the buddy says, well, I sold mine for this. And they think the businesses are similar, and so they will say, well, that's what I'll get for it. And someone comes along and makes the offer and they take it. Who knows, it could have been worth a lot more than that.

So best to get a valuation done by someone who's qualified to do it. And depending on the industry of the profession, it's good to have an expert at valuations in their respective industry.

When you talk about getting the correct valuation, or someone who can create the correct valuation, looking for someone who's experienced, has a good reputation, who is an expert in their field. So we know there's different methods of creating valuations, so I would love to walk through some of that with the viewers. What are some of the most common methods used, just standardized methodology, as well as what we do at OmniStar for our clients?

Anyone that has a business, they always believe that they have an idea of what it's worth. And so that's really where a valuation expert comes in. And some businesses can be valued very easily based on fair market value. So what are businesses like that business being considered, what are they selling for? And so you might say fair market value is a reasonable way to start. The problem is that no two businesses are identical, and so fair market value doesn't always give the best result.

And then you have something called EBITDA, and so that's become very, very popular. And EBITDA stands for earnings before interest, taxes, depreciation and amortization. So that's more of an accounting acronym, if you will, but a very popular way to value. And so a lot of business owners, they have no idea what their EBITDA is. That in itself is reason to get an expert.

And then you have something called discounted cash flow. That's one that I tend to subscribe to. I love that. Along with discounted cash flow, we're basically looking at cash flow in the future, and then we bring that back to a present value to help us determine what that company's really worth.

So to your point, Dustin, there's several methodologies. We like to take multiple methodologies, generally at least three of them, and then we bring those together to average what the value might be for that business. So comparisons, or comps, and then you take these methodologies, pull those together, usually get a pretty reliable number.

So those methodologies, they seem complicated, and it sounds like a lot goes into them. I know I like the discounted cash flow as well, because when you buy a business, yes, you could be buying materials or raw goods, but a lot of times you're buying the cash flow from the business. But there's so many pieces that go into the cash flow. What typically do we need if we're going to run an accurate valuation for a business?

Well, before I answer that, first, you're exactly right. Every business is a little different, and so yes, you could be buying some inventory, you could be buying supplies or assets or whatever it may be, to the point that you made. But at the end of the day, Dustin, no matter what the business, you were buying future cash flow. And people that don't see it that way, they're probably not going to make a good decision on buying a business or even selling a business.

The value in a business is what its cash flow can deliver now and down the road, and those forecasts are critical to valuing a business properly. So pro formas have to be designed, built, and then you can use those pro formas to bring back to present value what you think those future cash flows are going to look like.

What do we need to value a business? It always starts with a tax return. The tax return is, I like to say it this way, Dustin, the tax return is the gospel, because that's what the IRS sees. Now, some people might say, well, no, I want you to use these financial statements and not the tax return. Well, that's a red flag right out of the gate. If someone says that to us, we're not going to build a valuation for them, because something's not exactly right there. What is right is that tax return. If they're going to show that to Uncle Sam or to the IRS, then we can rely on that. So too can the banker.

So tax returns, all the financial statements. So most business owners are going to have financials given to them every month by their CPA or their accounting firm, and so those financials, P&Ls or a cash flow statement you want, income statements, balance sheets. So all of those things, along with the tax returns, for the most part, that gets us to the finish line in a valuation.

Now occasionally there's things that we have to figure out that aren't on a tax return, they're not in a financial. So specific to the business, the location, the type of business. There's a lot of things that you won't see on a tax return, but for the most part it's the financials and the tax returns.

Oh, great points. And I think that brings up another point I was just thinking about, is having a CPA, and having the right CPA, keeping track of all these, who have them, and if we need them or if a client needs them. And so having the right team is always so important. We talk about it a lot: having the right financial advisor, having the right CPA, having the right estate planning attorney, property casualty. All of it's so important, and when everyone's working together, it makes everybody's life so much easier. So if you don't have the right CPA and you're a business owner out there, make sure you look for one. And if you need a recommendation in Wilmington, we have plenty of alliances, and we'd love to help you.

Make a really good point. You got to have the right team. I don't care what your business is. Without the right attorney, the CPAs, and it could be more than one of each of them, and the right wealth management group, people that have the functional competency to do this kind of planning. Look, you spend your career building these businesses. What you never want to do is sell a business for the wrong price. You don't want to give away what you've worked a lifetime potentially to create, and it could be a huge amount of money that you're depending on as part of that overall wealth management plan. On the other hand, you don't want to overprice your business so that it never sells. So you've got to be sure that that valuation is done correctly.

You want to deal with people that have experience. Our experience is, certainly we've done some in the manufacturing world, but our experience is more on the medical side. That's really where we shine, because we know the industries. So if we don't know the space, we really don't want to take the valuation and even attempt to complete one, because we might miss little things, little nuances that could change that valuation. So expertise is a huge point that a business owner should be considering.

So there's a lot of work that goes into building these valuations. So I'm just curious, and I'm sure you all are curious: what is the average cost of a valuation, and what's the range, and what do we generally charge for our valuations?

What a great question that is, because it's all over the board. I've seen valuations, I've seen them go well beyond ten thousand dollars. I've seen them under ten thousand dollars plenty of times. We're typically in about a three to six thousand dollar range. Could be a little more than that.

But Dustin, we do it two ways. If you already have a valuation, as you know, we'll look at an existing valuation and basically tell the client if it makes sense, is it right. So we're essentially reviewing. We might make a tweak here or there, but essentially we're telling the client you can depend on this valuation or not. That's on the low end of the scale. That's more of that three thousand dollar range.

But if we have to go in and do all the legwork, the tax evaluation, we have to go get the tax returns, look at all the financials over the last three, four, five years, build the pro forma so that we can pull back from that pro forma what we need for discounted cash flow or the capitalization method. All of that takes lots of time, lots of effort and a lot of research. So those can easily run in the four, five, six, maybe even seven thousand dollars. But well worth it when you're talking about a multi-million dollar business, and the rest of your life being much better because you did better on the sale of your business. So it's a small price to pay to get something that's reliable.

That was what I was going to say, is the value's there. Because when you think about it from a financial planning standpoint, and this brings up another good point, is if you're not running your business sale through your financial plan, and what that's going to do for your retirement income, and what price you actually need to sell your business for to be successful long term, you really ought to be talking to somebody. Because you really shouldn't know what that number is, and hey, do we need to work a little bit longer, or are we even going to be able to get that price, or do I need to save more in the meantime, should I bring in another partner, or whatever the case may be. But just knowing where you're at today and then forecasting out what that sale could look like, that's going to give you a lot of clarity on what you need to sell it for.

Yes, valuation is important. Yes, we want to make sure it's accurate. But before you're selling a company, I think it's so important to know that it's part of a financial plan, a complete picture of your life, where you are today, where you're trying to go. Then the wealth advisory team can say your business needs to be worth X to complete your plan. And if it's not worth X, how do we get it there? What kind of money will you need to put into that business to either scale it or grow it to a point that it will allow you to complete the plan? That part is so critical.

Valuation doesn't matter if you don't really know what the business needs to be worth to complete the plan. You could be disappointed. Best to know what that is, and then you have goals to shoot for. And as you shoot for those goals, you're doing valuation work every year, every few years, Dustin, to see if that number's moving in the right

direction that definitely is the most important piece about business valuation is what does it need to be worth, but then how can you get it to that number? There's just so much. It's a very complicated arena. Having a team of people that can help you with that, very important. You certainly don't want to go it alone, and you don't want to do it with people that don't have experience to help guide you through what I think is a very complicated, it's a very, very complicated process.

And that's the reason why the business planning is one of our 10 wealth management elements. It's so important, and it is very complicated, and if you own a business, this is the financial plan in itself. Yes, there's a lot of other elements, but we spend a lot of time in this business planning element.

Phil, thank you for your time. Appreciate your expertise. To all the viewers, I hope that was very helpful. Remember, you don't have to go it alone. Please talk to your financial advisor, or if you just like a second opinion, the team here at OmniStar is more than happy to help. Any business questions, business planning, business valuation, or really anything in the financial plan, we're here. Please don't hesitate to reach out.

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