To their detriment, most small business owners spend their time working in their business rather than on their business. If you understand the value of your business, though, you can sell it, inherit it to family or pass it on to friends or extended family.
One thing the LGBTQ community lacks is a strategy for building generational wealth. For LGBTQ entrepreneurs, passing on their small business to a younger LGBTQ person can be a great opportunity to create generational wealth in the queer community. To do that and to ensure our small businesses last longer than we do, LGBTQ small businesses should each perform business valuations.
On this episode Queer Money™ about business valuations, we’re joined by AVP of Business and Market Development at MassMutual Financial Group Tracy Shaw. Shaw explains the fundamentals of business valuations, discussing how business valuations and buy-sell agreements guide retirement, estate and succession planning for small business owners.
Hear more about why you need a business valuation here:
What is business valuation and why is it important?
“A business valuation is critical for a business owner for a multitude of reasons, mostly because it gives them a sense of the health of the business that they’re building,” Shaw starts. Additionally, the top-line business goals of most entrepreneurs rely on it. Such top-line business goals often include marketing their great idea, fulfilling their passion, a drive improve something, supporting their loved-ones or protecting their own future. The best way to tend to all of these goals understanding what’s driving value for their business.
Shaw says that MassMutual finds repeatedly that business owners start with a great vision of their product or service, identify the steps to monetize it, calculate how much money is needed to grow their business and consider a possible succession plan, which is most effectively completed with a business valuation. Unfortunately, many don’t follow through with the final piece.
Shaw says, “It’s almost like joining a fitness club: They’re all enthusiastic at the beginning, and then they begin to wane when they realize how much it takes to truly work on their business, not just in their business.”
Should entrepreneurs fear business valuations?
Shaw admits that doing business valuations can seem scary, it can feel overwhelming, but business valuations don’t have to be negative experiences. There are lots of resources available for business owners get do proper valuations at minimal or, sometimes, no cost before they invest in larger business valuations requirements.
When and how would a business owner use a business valuation?
Shaw’s advice is to “begin with the end in mind.” It’s exciting starting a business and birthing a vision. However, it’s likely that business owners won’t always be at the helm of their business. In preparation, these leaders should ask, “What do I want my business to represent along the way?”
“Think of your business like your 401(k),” Shaw advises small business owners. If they were still an employee, they’d look at their 401(k) statements regularly to ensure they had the right investment allocations and were driving toward retirement goals. She continues, “Do the same thing for your business.”
Entrepreneurs should be clear on their exit plan. An exit plan could look a few different ways. It could be a succession plan. It could be a retirement plan. It could be an estate plan. A business valuation helps business owners assess if they’re building value to achieve their stated goal.
What is a buy-sell agreement, and why should I care?
Buy-sell agreements are safety nets for the business and business owner that asks, “What’s the least disruptive way for me to leave my business?” Owners can sell or designate heirs their share of their business. Knowing the value of their share, whether 50% or 100%, helps draft an accurate buy-sell agreement. The only way to value that is with a business valuation.
Currently, Shaw says, only about half of all small business owners have established buy-sell agreements.
According to MassMutual, Shaw says, 25% of business owners have valued their businesses on their own. Most studies, MassMutual’s included, suggest that six in 10 of the 25% of business owners who conduct their own version of a business valuation either over or undervalue their businesses. Thus, in an acquisition, they don’t get all that they deserve.
An additional concern, Shaw shares, is that 50% of business owners claim to have conducted proper buy-sell agreements and “a good number of them are unsigned.” Consequently, business owners perform business valuations, negotiate with business partners their buy-sell agreement, then never sign the buy-sell agreement. Skipping this step makes it harder, if not impossible, to execute the buy-sell agreement according to the business owner’s wishes.
What are the 5 ‘D’s of buy-sell agreements?
There are typically five reasons someone leaves a business, Shaw says: they die, they become disabled, they divorce a spouse, they depart for any number of reasons or they become disqualified, meaning the owner loses licenses or legal rights to run the business. The first four types of departure are best managed with buy-sell agreements supported with proper business valuations.
How often should a business valuation be done?
Business valuation should happen at several times, when a business owner believes there’s been a change in value, a change in ownership or family situation or, at least, every three years. Other occasions include moving from the start-up phase to the growth phase, moving from the growth phase to the maturity going from the maturity phase to the transfer or succession phase in the business life-cycle.
Finally, cursory reviews should be performed annually to ensure all documents are in place, including buy-sell agreements, documented succession plans and retirement plans.
What is a succession plan?
According to MassMutual, only 57% of small business owners have a documented succession plan. “Succession plans are essential to the continuation and legacy of businesses,” says Shaw. Succession plans answer the short-term and the long-term question of “What happens next?”
“While 57% of small businesses have documented succession plans, typically only one in four successors know they’re the successor,” Shaw cautions. Importantly for LGBTQ business owners is whether a business has been certified by the National LGBT Chamber of Commerce (NGLCC). The NGLCC has requirements to qualify for certification that succession plans must include to ensure the certification continues.
When a majority business owner obtains such certifications, their business valuation is contingent on those certifications continuing. Such requirements should be included in a succession plan or the business may be disrupted.
Can a proper business valuation and succession plan create “generational wealth” within the LGBTQ community?
Generational wealth is typically defined as passing assets or wealth from one generation to another within the same family tree. Many LGBTQ small business owners don’t have that option and, therefore, their businesses transfer to non-LGBTQ people or die when they die.
The LGBTQ community should adopt our own definition of “generational wealth.” That means transferring wealth or business assets from one LGBTQ person to another, non-familial LGBTQ person. Such an inheritance strategy would strengthen the LGBTQ community.
Proper business valuations and succession plans can create such generational wealth. “When it comes to dividing up the ownership of a family business, ‘fair’ doesn’t always mean ‘equal,’” she says. Thus, important questions for all small business owners, whether gay or straight are, “Who will be working in the business, and who will benefit from the business?”
Business valuations and buy-sell agreements are the final and often missed steps to grow a long-lasting business, and they’re less cumbersome than the consequences of not conducting them. So, reach out to your financial advisor today to set your business valuation in motion.