Business Valuation Blog | Understanding Buying / Selling a Company

When you decide your company needs to be valued for whatever reason, whether you are seeking additional working capital, taking on new investors, buying out a partner, retiring, or in the middle of a personal or professional dispute, you want the end result to be supportable and reasonable.

It’s important to keep in mind that the appraiser you select knows little to nothing about your business until you begin to communicate and share information. The first half of the process will be a fact-finding mission, with the goal of providing sufficient financial data and other key information to the appraiser, while they suggest to you the best approaches and methodologies to take.

This level of communication and data flow will also present the valuation professional with a better understanding of the larger picture, whether that involves a critical transaction you are trying to close, the settlement of a divorce or partial buyout, or providing you with a value that can be presented to potential purchasers in the open marketplace.

A third-party valuation is independent and unbiased; however, this is the chance to present your individual perspective as a business owner so the appraiser understands what you’re trying to accomplish, and certain variables that only you may be aware of that could influence the outcome. Trust that the professional working with you will understand how best to consider all the potential adjustments and make reasonable decisions in the overall scheme of their analysis.

As a result of these meaningful communications, the second part of the valuation, which involves the appraiser’s review, research, analysis, and report writing, will result in a thoroughly examined and reliable outcome. It likely will also end up being more in line with your expectations. No business owner wants to go through the effort of working with external consultants and service providers only to end up with surprising, undesirable results.

Many business owners might believe the value of their company is more than what the market might dictate; that’s just human nature. However, the more the appraiser understands your experience and specific history working every day as the head of the company, the more likely the final value opinion will be in line with your expectations.

Before you commit to a specific appraisal professional, spend time discussing these kinds of topics so you feel comfortable that you will be working with a well-balanced firm that understands the important factors that go into a business valuation.

I hear the phrase “the value is the value” oftentimes when discussing appraisal work with those not familiar with the profession. With machinery and equipment appraisals, the primary differences in value are fairly straightforward. They tend to correlate to the approach you most heavily rely upon and the definition of value that's estimated. Fair Market Value - Installed will drive a considerably higher value than any type of liquidation premise.

With business appraisals, it goes even further. Liquidation value is typically not a factor assuming the company is ongoing; however, the specific reason why an appraisal is needed will dictate the appropriate methodology and approach that best fits that perspective.

For example, if the purpose is for an outright sale of the company in the open market, the appraiser might need to back out the on-hand cash and liabilities from the balance sheet given the likelihood that the seller will cash out the liquid assets and be obligated to settle the liabilities at closing.

If the purpose is for a minority share buy-out or buy-in, the business appraiser will need to consider applying lack of control discounts to the overall value of the business when calculating the percentage share associated with the transaction. In other words, if 100% of the business is worth $500,000, a 20% non-controlling share will be less than $100,000, given the minority investors’ lack of control.

Another example may be a divorce scenario, where the company is being valued as part of a contested or negotiated division of assets. There may be factors pertaining to the ongoing litigation or settlement that will need to be considered before finalizing the value.

From a methodology perspective, it is quite often that a business appraisal can be reasonably valued using more than one approach. How these differing conclusions are weighed will factor into the overall estimate of value.

There is always going to be a level of subjectivity with any appraisal. Opinions will differ, depending on the data that is relied upon, the methodologies ultimately utilized, and the experience of the appraiser, who needs to make reasonable decisions to conclude on value.

When you need a business appraisal, take the time early in the process to cover these topics so you understand the approach that will be taken and ensure the methodology fits the overall purpose driven by the larger transactional picture.

When there’s a need to settle someone’s estate, there are a lot of things to consider, and given the emotional component of this difficult and hectic time, it can become overwhelming. If the individual wholly owned or was a partner in a business, you will need to consider placing a value on these estate assets, to properly and fairly include them in the settlement. It’s important to work with an experienced independent appraiser who understands the best methodologies to consider and has no “skin in the game” that might create a biased opinion.

When reviewing the ongoing businesses under the estate, it is also a good idea to look ahead at how you believe the future of the company may be affected by the prior owner or partner no longer being involved. Is there an opportunity to sell the company before the effects of their absence take effect? Are there factors to consider in taking the company forward under new direction or management?

While you’re taking care of the short-term demands involved in settling the estate, discuss these more proactive topics with an appraisal professional who can provide options where the valuation might consider these additional perspectives. It’s often feasible for an appraisal consultant to assist not only with valuing the business as of the effective date under the estate settlement but also look ahead at a more current date for the purposes of a future sale or change in the structure of the company.

Before you decide which consultants to engage with during this trying time, inquire as to their ability to work with you on multiple fronts so you can accomplish more than the immediate objective and determine if they can assist with all or most of the concerns you may be thinking about today.

It’s difficult enough to handle all the tasks involved with settling an estate, especially if the individual owns a large number of assets. The more support you have to accomplish all these, the better your ability to manage everything in a timely and effective fashion.

If you are in the middle of an estate settlement, consider reaching out to professional consultants such as certified and accredited appraisers, who will be there the moment you need the assistance.

In a perfect world, the advice and opinions that professionals provide you and your business regarding expected events would always occur exactly how they thought they would. In reality, the number of variables that can potentially impact the results of any transaction, from a personal or business perspective, are many, and the best anyone can do is reasonably understand them and estimate how they will impact the situation.

In the valuation world, appraisers are asked to opine on value based on the variables pertinent to the overall transaction in consideration. The end result is a well-thought-out estimate of value considering the market information they research and the internal data they are provided with to analyze.

From an owner, investor, or seller’s perspective, the conclusions can be reasonably relied upon; however, they are not guaranteed. An appraisal should not be considered absolute but can be used as a basis for negotiations between concerned parties, whatever their interests.

From a purchase or sale perspective, in an open market, there are many variables at play when trying to trade these assets. The final sale price should be within a reasonable range of where the appraised values were estimated. There may, however, be unforeseen factors that influence the transaction that an appraiser cannot foresee occurring, and that are inconsistent with the assumptions made.

Appraisals can also be used as guidelines in settling disputes when there is no agreed-upon or negotiated value associated with situations like a divorce or partner buyout. Differences of opinion are commonplace when it comes to valuing assets, whether that be with machinery & equipment, personal property, real estate, intangible goodwill, or the overall worth of a small business. Experienced appraisers who are accredited or certified in their specific field can greatly assist in facilitating a successful outcome where these differing opinions exist.

One of the primary reasons for hiring appraisers is to create an independent unbiased opinion that is well-researched so the parties directly involved and those ultimately making decisions in the matter can have an impartial perspective to assist in rendering their own decisions.

Like most things in life, nothing is guaranteed; however, having reliable and supportable opinions can go a long way to realizing a favorable outcome.

Like many professions, the appraisal industry is full of acronyms that only those well-versed in the lingo can identify at first glance. Here are a couple of abbreviated terms that will factor significantly in the overall valuation of your small business.

EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortization

Even the long version of this acronym is confusing to understand. Here is a short discussion of its meaning and purpose:

EBITDA is a measurement to determine a company's profitability or cash flow, however, it may not fully represent cash earnings. EBITDA considers a wide range of factors in business finances. It is considered a universally accepted appraisal measurement and is also used in accounting circles.

From an application perspective, it is used by banks and financial services companies to estimate debt servicing levels. It is also used to compare similar businesses within an industry or market and as a tool to preliminarily estimate a company’s current value using multiples of EBITDA developed from historic databases.

SDE: Seller’s Discretionary Earnings

Seller's Discretionary Earnings (SDE) is a calculation that considers the net profit of a business while adding back discretionary adjustments to show the entire financial benefit provided to an owner.

SDE is a common income measurement calculated when a business is changing hands. Financial data associated with this calculation include EBITDA, as well as other factors that impact a company's value as you engage in a buy/sell transaction.

If you're on the purchase or acquisition side, SDE provides you with the information needed to develop a reasonable estimate of your expected future return, as well as an understanding of realistic expectations for the continued growth of the business. From the seller’s viewpoint, SDE supports an optimal level of value during sale negotiations. SDE allows both buyers and sellers to make informed decisions while preparing to invest in or exit a small business.

In summary, these are only 2 of several acronyms commonly utilized in the business valuation industry. Our next blog will discuss other terminology that may be important to better understand when you decide to appraise a privately owned company.

When it is time to close a business and there are no realistic sale options, there are several steps needed to officially dissolve the company, so no loose ends come back to affect you in the future. One of those requirements is filing forms with the IRS and/or your state for final tax settlement purposes. Depending on the structure of your prior operation, you may need to obtain an independent business appraisal as part of this process.

Here are a couple of things to consider when a final valuation comes into play.

Transfer or Sale of Assets

If your business owns a lot of equipment or vehicles, you will look to estimate a final value if you plan to sell them or transfer the property to another entity, such as a new company, or to yourself. This will show a clean break between when the old business was responsible for the assessment and when the new owner took over responsibility for them.

A machinery & equipment appraiser can complete this report as part of the overall business valuation.

If you own intangible assets such as patents, trademarks, domain names, customer lists, or transferable software, the value of these would be estimated by the business appraiser as part of any remaining goodwill of the company.

Valuation Methodology

The focus of the business closure appraisal will likely be solely on the remaining tangible and intangible assets; however, if there are any remaining accounts receivables, payables, long-term debt, or revenue streams not yet fulfilled, these will need to be considered as well.

The asset approach will probably still be the driving methodology utilized by the appraiser while adjustments are made to take these other factors into account.

In an ideal scenario, when it is time to move on from a business, you will be able to find a buyer that allows you to maximize the company's remaining value. If shuttering the operation is your only option, there will likely be additional housekeeping tasks to take care of before you segue to the next chapter of your career.

To learn more about these requirements, consult your accountant and an independent valuation expert who can provide further insight.

One of the more common requests we receive to complete a business valuation pertains to divorce cases. Whether it is for cooperative mediation or a more complex dispute involving litigation, independent appraisal work is often required when one or more of the parties owns a company that is deemed part of the shared property.

Any type of dispute, whether personal or professional, can be difficult to settle when differing opinions are held by each side. An independent professional appraiser can assist by taking an objective and unbiased view of the business and its underlying assets to estimate Fair Market Value.

The most important component from the valuation perspective is access to complete and accurate information. Without cooperation from all parties involved, the appraisal effort cannot move forward. It is imperative that the requested financial data and background summary of the business be disclosed in a timely manner to avoid delaying the process indefinitely. Once the valuation professional has all the necessary details behind the company, the appraisal can be finalized efficiently and effectively.

Even though the appraiser is typically engaged by one of the ex-spouses involved in the divorce, they have an ethical obligation to not take sides, and their work product is meant to be a tool to facilitate the decision-making required by the judges and arbitrators involved with the overall mediation. There are a number of other issues at stake in a divorce case, and the appraisal may be just one of these; however, differing opinions of value are quite often material in nature and can have a significant impact on the final result.

No one truly wants a divorce to drag out all the way to trial, including the independent experts assisting in the matter. As difficult as the situation may seem for those directly involved in divorces and related disputes, the only way to move towards a conclusion is to assist in the processes required to fairly disclose and measure the value of the assets. Speak with a certified professional appraiser with experience in these matters to learn more.

We discussed in our last post the three most common methods utilized when performing a valuation for small businesses:

• Capitalization of Earnings method under the Income Approach
• Direct Merger & Acquisition Method under the Market Approach
• Adjusted Net Asset method under the Asset Approach

Depending on the overall scope of work involved and the structure of the company, only one or two of these methods may ultimately be relied upon.

For example, let’s look at a typical holding company, which is often structured as more of an investment business versus a traditional revenue-driven operating company. Common holding entities will own assets such as real estate, securities, heavy equipment, mineral rights, or even a group of smaller operating businesses. The assets may be rental properties or those commonly traded in the market. These holding businesses are often utilized to consolidate ownership interests and management structures while creating certain benefits and protections for the owners.

Regardless of the structure or the assets being held, revenue produced by these companies is meant to simply sustain operations as opposed to drive income and profitability. Therefore, appraising a holding company using the income or market approach methods would not be practical. The value of the underlying assets would be more appropriate utilizing the adjusted net asset method.

A business appraiser will need to rely on independent appraisals to confirm the value of the primary assets while adjusting for cash, receivables, liabilities, and other balance sheet items. It would not be prudent to simply rely on estimates supplied by the business owner without these unbiased reports.

Another issue to consider when valuing a holding company is the possibility of a discount for lack of control with the ownership interest being appraised or for a limited degree of marketability. These types of discounts are considered with any small business that has multiple owners for partial buyout or buy-in purposes, or for potential liquidity issues arising from a sale.

Holding companies should not be confused with “shell” companies, which are structured for different reasons, such as tax and accounting regulations, and are often the subject of negative press due to a history of investigations into the validity of certain enterprises. To learn more about appraising holding companies, consult with a certified valuation professional.

A Business Appraisal relies on three broadly accepted approaches that consider all the potential variables that factor into a valuation: The Income Approach, Market Approach, and Asset Approach.

These approaches review and analyze historic performance, reasonable growth projections, and the underlying assets of a company to estimate value. Depending on the circumstances, one or all three will be weighed in the final assessment.

Within these three approaches, there are a multitude of methods by which business value can be measured, however, when appraising a small privately owned company, there are typically only three methods utilized. Here is a brief summary of each:

The Capitalization of Earnings Method under the Income Approach

This method looks at the future projected growth of a business where historic revenues can reasonably predict ongoing trends over the next few years. Future cash flows are discounted back to the present date of the appraisal to establish value on a current basis. This method is most appropriate when a small business has shown a relatively steady level of revenue and income over the last 3-5+ years.

The Direct Merger and Acquisition Method under the Market Approach

This method estimates the prices paid for closely held companies that are in a similar line of business and can be considered comparable. Based on the data available in the market, it develops multiples that can be applied to the gross revenue and discretionary earnings of the business being appraised.

The Adjusted Net Asset Method under the Asset Approach

This method reviews all the tangible assets in the company, including real property, equipment, F&E, and inventory. Estimates are ideally based on an assessment of market value, or if that is not available, net book value. It also factors in cash, receivables, and liabilities to realize a net asset value. This method can be applicable if a business is capital-intensive but not producing a lot of revenue or net income, while also being appropriate for a company that is winding down operations.

In summary, you can discuss these methods in more detail with a certified valuation professional to better qualify which approach would likely apply to your small business. Taking the steps necessary to understand these approaches and methods before committing to a business appraisal will help you avoid any unexpected surprises.

Occasionally, appraisers are asked to provide opinion letters based on a review of another appraiser’s work product or from a company’s internal analysis for which they need independent validation. This process can seem more simple and informal than a typical valuation project, however, the time involved with completing the effort can be as much or even more than an appraisal.

Those businesses looking for a less expensive and time-consuming alternative to a complete appraisal will find the result can often be the opposite. Reviewing third-party work and commenting on their opinions and estimates for reasonableness, creates a two-fold process that can be more complicated than reviewing financial and asset data while estimating value.

At the very least, the appraiser needs to complete a high-level valuation of their own in order to comment on whether third-party opinions make sense or not. In many cases, the analysis required to provide a supportable opinion of another’s work product involves a similar amount or even more work compared with simply providing an independent appraisal of their own.

Opinion letters typically need to be generated from scratch given each project is unique and the requested deliverable will change with each engagement. With standard appraisal reports, most valuation professionals rely on a boilerplate framework that provides a more efficient way in which to develop their narrative summary.

Another issue with requests for review opinion letters is that many certified and accredited valuation professionals are not comfortable providing this type of report. The need to go outside the lines of their normal framework may create too many inconsistencies with the formal appraisal practice requirements that are adhered to in the normal course of business.

“Informal” is not a word appraisers like to use when providing opinions given the uniform standards they must commit to in their profession.

Typically, it will make more sense to have the appraiser complete their own analysis and valuation report which can then be compared to the other party’s work effort. This may seem repetitive and more costly; however, you may be surprised at the additional benefits you will reap when your auditors have an easier time approving the total work product. And there is a high likelihood that the time and cost involved will be very similar or even less when you ask for a more straightforward scope of work to complete the task at hand.