Business Valuation Blog | Understanding Buying / Selling a Company

 

There will always be differing opinions as to why the US, and the world in general, are facing significant challenges from inflation, supply chain delays, post-COVID hangovers, and many other economic factors that may have a negative impact on your family. If you own a small business, these issues can also impact your revenue and cost structure while creating new concerns you have never faced before.

In some cases, I have seen opportunities arise from these challenges, going back to the start of the pandemic. Savvy business owners have taken advantage of new markets during these difficult times, while others simply had no alternative options other than attempting to outlast the downturn. These latest economic issues appear to be seeping into every industry and business, from technology to energy to food markets, with no short-term solution in sight.

Regardless of the type of business you own and the effects the economy has taken on it, it might be a good time to consider reevaluating your company, given the recent changes that have occurred as a result. Taking a hard look at the state of your business can provide you with the ability to adjust course in certain key areas where revenues and expenses are concerned.

As we have all seen from past experience, there is always a light at the end of the tunnel, regardless of how long and dark it may be. Planning ahead with a strategically revised business plan, starting with a current assessment, can proactively put you in front of the competition.

Your future success and that of your business can, in part, hinge on creating new ideas that will open up opportunities created by these downturns. While many will continue to gripe and complain about the state of the world and how it negatively affects their livelihood, you can look to be one of those who seize the moment through insight and careful planning.

 

One of the biggest challenges small business owners face is keeping track of all their records for sales, costs, and everything in between. Being organized is critical when it comes time to value your company for a sale, new investor, or any other reason. It will require a lot of information be given to a certified appraiser, who needs to understand the details behind the numbers.

Tax returns, income statements, and balance sheets are the most common types of documents recorded annually, however, these figures may not tell the whole story as the value of your business is determined. Certain expenses will be fixed, while others may be variable and discretionary, which should be discussed with the appraiser so they can make adjustments to the bottom line that otherwise might be missed.

Is it important for you to understand the value of certain tangible and intangible assets as part of the appraisal? The business appraiser will rely on your depreciated tangible asset levels unless you can provide recent equipment or real estate fair market reports, which may show considerably higher figures. Some appraisal firms have the capability of valuing these tangible assets concurrently with the business appraisal as part of the overall project.

The intangible value will normally be picked up within the general goodwill category. If you believe there is significant worth to specific assets such as; customer relationships, contracts, trademarks, patents, websites, or similar intangibles, you will need to provide details that can be supported by revenue streams and related data.

It is important to not only provide the appraiser with as much realistic backup data as you can but to also stay involved and be available to answer questions that may arise during the valuation analysis. These tactics will lead to an optimal outcome while supporting reasonable conclusions for the overall value of your business.

In the aftermath of the pandemic and in consideration of continuing economic hardships for many businesses in highly affected industries, such as restaurants and entertainment venues, the reality is that a lot of companies did not survive. These unprecedented times saw a large increase of small business owners struggling to stay afloat in hopes of a turnaround that ultimately took too long to come about.

Despite short-term relief funding programs made available by federal and state governments, there has been a significant increase in small business closures beginning in mid-2020 and continuing to this day. One of the many obligations business owners are required to undertake when closing their company involves a formal discharge and dissolution filing with the IRS.

There are several filing forms involved and depending on the existing documentation, owners may need to engage with a certified business appraiser to independently declare a final value for tax purposes. Even though it is evident that little to no revenue is being generated from business operations, there likely remain certain assets and liabilities which need to be declared as part of these final steps.

As painful as it may be, a business appraiser will need to be engaged and review these documents as part of their work effort to establish a fair net value for the remaining tangible and intangible property. Essentially, the focus is on what remains of the business that can be resold as part of the closure.

In many cases, this would be tangible property only, such as real estate, buildings, machinery & equipment, and personal property. If these assets have recently been appraised or are reasonably depreciated and accounted for on the company books, the business appraiser can use this data to document under an Asset Approach to value. This approach will likely be the only one utilized given the lack of income and external market comps considered under more normal business valuation circumstances.

Other factors will be taken into consideration that pertain to the closure status which will hopefully soften the final blows that come with this process. Making the decision to close your small business for lack of profitability, or for any other reason, can be a heartbreaking experience, and as business appraisers, we will do all we can to facilitate this process for small business owners during these trying times.

Our blogs primarily cover topics related to the appraisal of small businesses however, there are other options for owners who may be in the middle of a potential purchase, sale, investor buyout, or dispute where a recent valuation exists, and there is a need to obtain an independent opinion on the reasonableness of the conclusions in the report.

This is considered a consulting or review engagement where a certified business appraiser will review relevant documents, and provide opinions as to the approaches, methodologies, and conclusions developed to arrive at a value for the company.

Review work is a more informal process where the consulting valuation professional will develop opinions of work already completed and potentially offer alternative perspectives as to valuing the business. Ultimately, they may determine if an adjustment is warranted to the value concluded upon in the report while providing support as to why; or they may state that the appraisal was well conducted and the value conclusion credible.

The review appraiser may also provide an opinion as to the credentials of the appraiser and the overall quality of the written report from a compliance perspective.

Much of the work that goes into a valuation review and consulting assignment is consistent with completing a business appraisal, given the need to support why the existing report conclusions may be reasonable or not. The primary difference is that the review appraiser is not completing a formal, certified appraisal report of their own. A preliminary opinion of value may be presented as part of the deliverable, in the context of the work performed and documents reviewed however, it would not be considered a certified appraisal.

In summary, these types of engagements can be useful anytime there is a concern regarding the reliability of existing appraisals being used as part of a business transaction or in settlement efforts for a buyout or dispute. The consulting assignments are quite common in the valuation industry and offer an alternative option to business owners in situations where a completely new valuation report may not be necessary.

Consider engaging with an experienced certified appraisal professional when you enlist this type of work to ensure you receive a supportable, well-researched analysis, that provides the additional independent perspective needed to make the most informed decisions.

Believe it or not, Millennials are now in their late 20s and 30s and have become the most sought-after consumers of products and services for most commercial providers across all industries. Gen X and late-stage Boomers are still in the picture, however, over the last couple of years, it has become evident Millennials are making tremendous strides in gaining buying power due to a variety of circumstances.

In the valuation world, I have recently seen a growing number of young entrepreneurs and next-generation family members running companies with fresh perspectives that can’t be ignored, and will likely set the pace for the next 20-30 years of business development across the world. Many of these individuals have patiently bided their time during unprecedented events that have forever reshaped our future over the past few years.

Others have mocked them in the past for their habits and preferences, while underestimating their potential, and not realizing the vast majority of this generation are nothing like the stereotypical picture painted by so many who are engrained in “old school” mentality.

While it is generally true that Millennials had a tougher time breaking into the mainstream workplace a decade ago in a much different business landscape, they used conservative tactics in an effort to save money, such as living at home and holding off on marriage and family plans until more financially secure. This is somewhat of a unique circumstance created by this generation, however, we are now seeing the emergence of a hungry, wizened group that accounts for over 20% of the populace, well over $2 trillion in spending power, and 90+% employed.

Virtually every major entertainment event, both live and virtual, sees its advertising revenue campaigns geared toward these consumers, while the majority of the workplace is inhabited by those that fall into the Millennial generation. These trends, which have quickly grown over the last 5 years, are the building blocks for the future leadership of our nation’s business, economic, and political climate. It is not a surprise then, that this generation is becoming the focus of many service industries and product developers who realize that staying ahead of the competition will equate to favorable ratings from this group of individuals.

Millennials are the original masters of social media, and with venues such as Twitter, Facebook, LinkedIn, and Instagram becoming dominant platforms for advertising, it makes total sense that the two are becoming entwined with how future businesses will be run.

In summary, if you own a small business, and are looking for growth opportunities that have otherwise been difficult to develop, consider targeting the Millennial generation as a potential expansion to your client base, and look to keep up with this new and exciting group as they continue to take over the future.

If ever there was a light at the end of the COVID tunnel, it may be at its brightest today, however, the topic of broad-based remote employees becoming a permanent way of life has been discussed for a while now. Do you find your business in the middle of this challenging issue or is your company fully reliant on in-person employment to operate

Businesses involved in markets such as manufacturing, packaging, and logistics will always need certain employees on the “factory floor”, while service providers such as advertising agencies and accounting firms are finding it easier to allow a majority of their workers to have the option for remote or home offices, either part or full time. So many things we used to do in person can now be conducted remotely and virtually.

The fact is that the in-office, in-person dynamic is becoming a thing of the past, and while many employers are compelled to increase full-time remote workers, there are many challenges for both business owners and employees with this shift in the workplace.

From personal experience, I can confidently say that, for some people, it takes a long time to effectively and efficiently work from home, or in a remote office setting, with no hands-on supervision. There are dozens of ways to waste time and become distracted by influences completely outside of your job responsibilities. Working remotely can also hinder the ability to develop the kind of camaraderie many office environments afforded people in the past, which can be beneficial to creating a team dynamic and improving the business social skills of your employees.

That said, this shifting workforce dynamic is now considered the new normal and will continue to trend this way for many businesses in the foreseeable future. Employers will need to be more diligent in their hiring practices and employees should consider ways to eliminate distractions and develop habits which to balance home office work with some level of in-person company interaction.

Many business experts believe employees have all the leverage in the current market and that likely holds true for certain qualified skilled candidates. Most employers however are not naïve or desperate enough to allow their new hires to call all the shots. Career success inevitably comes down to overall work ethic, open-mindedness, and the ability to develop leadership skills while working in a team environment and ultimately becoming more effective than your peers. Employers now more than ever, should look to hire those with strong social skills, work ethic, and flexibility to go along with the technical skills necessary to do the work.

It will be interesting to see how the remote office shift in the workforce further evolves and how employers and their staff continue to adjust without sacrificing quality and efficiency and avoid a loss in overall business value.

Business owners who are enjoying steady growth over time with their sales volume moving ever upward will eventually need to determine whether it makes sense to subcontract out the extra work or consider bringing in a new hire on a part-time or full-time basis.

This decision depends greatly on the type of business you own, in that certain jobs involve tasks that can be accomplished from home or in the field, while others require the need to train and work within an office or factory environment.

For instance, as a business valuation and equipment appraisal firm owner, much of the time-consuming work for my employees revolves around field inspections and market research, while maintaining strong customer relationships and meeting delivery timetables. These job responsibilities lend themselves to working offsite in the field or from home.

Here are some other factors to consider:

• What are the maximum capabilities of your current staff? Can you structure an improved compensation plan for existing employees to benefit from this growth while not overtaxing them or potentially creating a lesser quality product or service given the extra work demands?

• This option should probably be considered and vetted before any others, as your personnel will appreciate the opportunity for growth. It will also help maintain positive morale if you ultimately determine the need for extra hires or subcontracting.

• Are you confident that your growth is a consistent pattern that will continue to develop or, could it be a short-term aberration due to unique circumstances in your market? It’s always a good idea to look back over the last 3-5 years of revenue and determine what created this growth and if there are inconsistencies or steady patterns to your sales.

• If you determine there is a strong chance the increase in revenue will continue in the foreseeable future, hiring full or part-time in-house will need serious consideration.

• How much training is required for subcontractors or new employees, and can you afford to bring in a seasoned professional who will immediately take the ball and run? Depending on your overall role in the business, you may have the time to train lesser groomed staff or freelance help however, if this is not the case, you may need to consider spending the extra capital to engage someone with extensive experience.

There is always risk involved when bringing in additional human resources. Taking a leap of faith with new hires or subcontractors can help ease the pressure and help you better manage growth leading to prosperous future outcomes, where the sky becomes the limit.

Image Source: MAHALAKSHMI License

Most business valuations involve a review of historic financial statements and current assets, with a comparison of existing competition for similar businesses in your market. The requirements change, however, when you have a startup operation that has yet to earn a single dollar and is still in its infancy.

Of the many decisions that you will be making during these early stages, how best to provide documentation as to the future value of your business to potential investors, such as private equity and your existing banking relationships, will likely be at the fore. Before you spend every dime of your own investment savings, you will want to consider alternate sources of working capital with these partners.

One of the tools you will need to independently support the value of your startup is a certified business appraisal. Without the existence of historic financial data, the appraiser will rely instead on your forecasted business plan, which will include projected revenue and expenses, as well as the tangible and intangible assets you have already purchased, or plan to acquire in the immediate future. These growth models are typically built over an initial 5-year period, and structured similarly to how typical financial statements and balance sheets are prepared by accountants.

The appraiser will utilize these forecasts to consider the value of your business today, assuming the business plan is realized while discounting the income streams using accepted methodologies for startups within your market and industry sector. They will also compare your growth plans to competitors in these markets who have similar businesses, to ensure the forecasts are in a reasonable range.

It is important to balance common sense reality with your aggressive growth plans, to ensure these potential investors, and your appraiser, are comfortable there is a good chance of success and that the forecasts are in line with existing successful companies. Many startups fail for any number of reasons, but two of the most common are poor planning and overly confident forecasts.

If you can find the right partners, who share your vision, while keeping checks and balances of the plans in place, and there are well-researched, realistic goals set, the chance of success will be much higher. Add a bit of patience and endurance into the mix, and you can set yourself up for the best opportunity of developing a profitable business for years to come.

As a business owner, there are many reasons why you may want to determine the actual value of your company. Here are some of the more common ones:

Business Sale

This is probably the primary reason a business valuation is needed. The sale of your company shouldn’t be finalized without an understanding of value. This will assist in negotiations and provide an independent analysis that both parties can agree on.

Ownership Transfer

You've put a lot of time and effort over the years operating your business, growing it into what you know is a strong successful continuing enterprise. One day you look up and realize it’s time to consider retirement or, at the least, take a step back and let the next generation take over the reins. To properly transfer ownership under this type of transaction requires a business appraisal to accurately reflect the value and determine a fair process to accomplish this final business goal.

Partnership Dissolution

Whether this involves a senior or minority shareholder stepping down or a personal divorce that needs to be settled, each party wants to realize a fair shake in the process. To avoid one side or the other trying to inflate or depress the actual value of the business, obtaining an independent appraisal will provide a solution.

Estate Settlement

When a business owner or senior partner passes away, it is an emotional situation. This can be further complicated when there are multiple investors and heirs to the business, some of whom may have different goals as to their settlement of shares. Some may want to liquidate the company, while others may want to continue forward and take over operational control. Engaging with a certified business appraiser to value the company and determine partial ownership interests can assist in settling all of these possibilities so the business and shareholders don’t suffer.

Merger/Acquisition

If your business is being rolled into a larger company as part of a merger or acquisition, the due diligence process will involve an appraisal of the business and its underlying assets. There are formal accounting principles and guidelines in place to complete this effort that an appraiser will follow to ensure the transition goes smoothly.

Going Public

If an IPO (Initial Public Offering) is in your future plans, after years of operating privately, you will need to determine value based on a targeted share price. There are a number of valuation techniques that can be used to compare your currently private company to a public one, allowing an appraiser to determine value and price those shares at a rate that is reasonable in the open market.

Liquidation

There may come a time when the business is not operationally profitable, and all forecasted redevelopment plans have been exhausted. In this case, a liquidation of the company will need consideration. Understanding and estimating the value of the company’s assets will be the primary driver in this circumstance, ideally with the purchaser giving some consideration for future operations.

Regardless of the reasons why a business valuation is needed, ensure you engage with a certified experienced appraiser that can work with you to facilitate a successful outcome.

Business owners likely have particular ideas about the value of their company and how best to calculate it, given their experience and knowledge of their financial history, and understanding of the market and industry in which they operate. When you need to formally engage an experienced, certified business appraiser to value your company, it's important to understand the standard accepted approaches they consider and weigh during the process.

There are three approaches to business valuation, namely the Income Approach, the Market Approach, and the Asset Approach. Each of these methodologies can be broken down further and considered based on the type of business you own, available data to analyze, and the company’s current operational status. Here is a brief summary:

Income Approach

The income-based approach has two primary methods that take into account whether the business income is steady or inconsistent. Essentially, the company's income is measured over a period of time to determine its overall value. Under a “Capitalization of Earnings” approach, the appraiser will consider both historic and future income probability, based on a steady stream of revenue, and discount these streams to realize a net present value, while using appropriate rates of capitalization.

Under the “Discounted Future Earnings” approach, the appraiser will estimate value primarily from future income probability, or forecasts, over a fixed period of time, to a terminal value, and discount this back to the present

Market Approach

>The Market Approach determines business value where the subject company being appraised can be compared to available businesses traded in the public marketplace. Adjustments are made to better match the private business based on revenue and overall size.

These guidelines are either investor-driven or transactional, depending on the data available. For example, a similar publicly-traded company may have available the price investors paid for minority interests in that company. This can then be adjusted to match the subject private business profile.

Other methods which take components of both the income and market approach are the “Multiple of Discretionary Earnings” and “Gross Revenue Multiple” which consider the actual income of the business being appraised and apply a market-derived multiple to these earnings based on available public data.

Asset Approach

As a general rule, the asset approach is considered and primarily weighed when a business is operating at a loss or has shut down temporarily or permanently. The options available to the appraiser under this approach are as follows:

Adjusted Net Asset Value: Under this methodology, the appraiser will adjust the company's tangible assets based on an estimate of Fair Market Value, while taking into account existing liabilities.

Liquidation Value: If the business has permanently ceased operations, and a compulsion to sell the remaining assets is the only remaining option, the value of the assets is measured under an Orderly or Forced Liquidation premise.

Book Value: This method relies solely on the net book figures of the assets recorded on the company’s books, without adjusting to market or liquidation value. Given accounting depreciation methods are usually accelerated, this will likely lead to undervaluing the assets.

Excess Earnings: This method takes into account the historic earnings of the company and provides a broad way to measure intangible asset value as well as tangible, by estimating the goodwill of a business along with personal property, equipment, improvements buildings, and land. This is generally preferred for fully operational companies with a lot of tangible assets.

By gaining a better understanding of these valuation methods, you will be able to work together with your certified, experienced business appraiser, in a successful fashion, to properly appraise your company.