August 11, 2020  
 
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Exit Planning and Valuation of a Small Business

Written by Samuel Muriithi for Gaebler Ventures

There are several reasons which may prompt a business owner to implement an exit strategy and all these call for astute exit planning. In making such an exit it is absolutely vital to conduct a valuation of the business in as accurate a manner as is possible.

The need for well thought out exit planning becomes a reality when a business owner needs to relinquish the control of his/her current entity so as to move on to higher things.

The same also applies when a business owner can no longer handle the day-to-day running of the business entity due to health problems or advances in age. Some of the most common exit planning strategies that are regularly implemented include:

  • The sale of the business to a strategic buyer who can be a customer, a competitor or even a supplier
  • The decision to manage the business entity for life
  • Enforced liquidation
  • Selling the business to a financial buyer
  • The liquidation of assets
  • The sale of the business to one's employees or heirs
  • Going public etc

Before opting for any of these exit strategies, you as the business owner have to make prior exit planning arrangements so as to earn an optimal reward. For example, when you need to attract a financial buyer your potential exit planning strategy can be driven towards optimizing the value of your business. This can be done by investing in superior manufacturing technology and reinforcing the product distribution structure. When selling to a competitor you can have your exit planning strategy take the form of a vigorous advertising campaign so as to secure a larger market share.

After exit planning has been duly arranged for you need to do some form of business valuation. Small business valuation can never be accurately done since there are so many variables to consider. Placing a value even on tangible assets is open to much debate. The final value attached to such an asset is normally based on its remaining life expectancy, an appraised value and its importance to business operations.

Intangible assets like goodwill, number of years that the business has been in existence, its location and the customer base thus accumulated are more difficult to place a value on. There are three general techniques for small business valuations i.e. rule of thumb, asset, and industry average valuation.

Rule of thumb small business valuation helps determine business worth using a multiplier that is related to cash flow and profitability. The most common multiplier in this case is the EBIT, i.e. earnings before interest and taxes, and it is multiplied three, four or five times to ascertain the business value. This is because businesses are expected to recoup an investment in 3-5 years.

Asset small business valuation is mostly conducted for businesses that are asset-dependent e.g. manufacturing firms, retail and wholesale stores etc. The value of these assets gives an idea of the business worth though some other factors including fair market value, inventory and owner benefit come into play.

Industry average valuation seeks to arrive at a ballpark figure that will then be used as a starting point for more accurate valuation. This figure is obtained from comparisons of the worth that has been attached to similar businesses that have been sold within the last 6-12 months.

Samuel Muriithi is a business owner in Nairobi, Kenya. He has extensive international business experience in the United States and India.

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