For the purposes of Key Person [Keyman] Insurance - Part 1

In the first of a four-part series on valuation issues for small to medium businesses, we explore why you need to know what your business is worth.

Own a publicly listed company or an interest in one and you know what the market says your interest is worth on any day of the year.  A private business is very different.  For most small to medium enterprises, there is no ready or automatic market that will tell you what the business is worth.

Some business owners have a reasonable idea of the fair value of their business, most don’t.  In some cases, value is an unknown, in others the perception of value is an illusion.

Some owners undervalue their businesses while others have a totally unrealistic view, seeing a level of value that does not exist.  Both alternatives are dangerous.

Knowing what your business is worth should be a fundamental of being in business.  This is not something that is important only if you want to sell the business or for succession planning.

Yes, it is critical to know the value for these reasons but you also need to know if you are looking to borrow, are expanding the business, when you need to assess business performance and the adequacy of your profits, or if you are looking to complete a restructure.

The value of your business is one of the key benchmarks against which you should measure your concern.  If you don’t know what it is worth, then you have no real frame of reference against which to measure your performance, and this could cost you a lifetime of underperformance.

Importantly, not all businesses are measured in the same way.  One reason many owners misunderstand the value of their business is that they compare it with another business that may be fundamentally quite different.

There are a number of different, generally accepted valuation methods for SME’s.

At a high level, the majority of businesses will be valued based on their earnings, their cash flow or their assets.

Different approaches will produce different results.  And the right answer is not the one that produces the best result, but rather the one that lines up with the fundamentals of the business.

As an example, a business that has a limited life with a defined income stream for that life is most likely to be valued based on the cash stream it will produce.  On the other hand, a mature business, such as a wholesaler, that is valued on a going-concern basis, is likely to be valued on a multiple of its earnings.  A business such as a farm is more likely to be valued on its tangible assets.

Risk influences business valuations. The higher the risk, in most cases the lower the relative value. Risk has an impact on the sustainability of earnings, the stability of the cash flow or the sale of the assets.  Irrespective of the valuation method used, variations in risk will influence value.

Risk is measured at an economic, industry, business and ownership level.  If you want to enhance business value then look to areas where you can reduce or eliminate the risk to the business without affecting earnings.

Ideally, your business is generating and increasing its earnings, its free cash flow and its asset base.

The factors and a positive growth trend are indicators of real value and a business that is likely to be growing in value.  The absence of these factors may put in question what value really exists.

Part 2. How To Find The True Worth Of Your Business
We ask why there are different valuation methods and which one is likely to apply to your type of business.
Go to Part 2

Key Person Insurance Services from RGIB Insurance Broking

RGIB Insurance Broking provides specialist insurance services for all Key Person [Keyman] Insurance requirements and can tailor solutions specific to your business’s own particular needs; including,

• analysing your ‘Key Person insurance requirements;
• calculating the level of cover to suit;
• helping to establish acceptable cover limits for key people;
• liaising with your accountant to get the figures right;
• helping to establish a value on the business/practice;
• helping to formulate Buy/Sell agreements for succession planning;
• negotiating with underwriters to tailor the best insurance cover at the most affordable premium;
• obtaining insurance premium funding;
• helping manage the ongoing Key Person insurance program – annual level reviews as well as at a time of claim to help ensure that the money goes to the right people at the right time.

It’s imperative to have an insurance broker such as RGIB arrange your Key Person insurance so as avoid any unnecessary complications at benefit payment time.

RGIB is Australia's most innovative insurance broker arranging more than AUD$5.5 Billion cover for over 6,000 business, liability & indemnity SME clients.

Specialising in business, public liability and indemnity insurance with Australian and International insurance companies ensuring clients a professional, efficient & fast service at the best available terms.