Business Valuation Blog | Understanding Buying / Selling a Company

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:

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.

When your small business is targeted for acquisition, it can be both an exciting and stressful time. It is important to prepare for this scenario as you grow your company, so when the day arrives, you have the tools in place to facilitate the process. Here are a few tasks to consider updating now to prepare:

Organize Your Business Documents

The acquisition process is lengthy, but it will go smoother if your financials, taxes, and transactional records are in order. Both hard copies and electronic files need to be organized so a third party involved in the due diligence can easily access everything they need in support of the sale. Make sure all taxes, insurance, and benefits are up to date. Sort through all historic company documentation to ensure it is consistent with the preliminary data provided to the acquisition team. This will save weeks and potentially months of time and minimize any red flags that otherwise would be raised during this stage of the deal.

Obtain Pre-Acquisition Appraisals and Update Them With the Collaboration of the Parties

Before you dive deep into a potential sale, have appraisals completed on your business, equipment, and real estate. A valuation effort will be completed internally by the acquisition team based on the data you provide them, however, suggest an updated business and tangible asset appraisal be performed by a certified and accredited valuation firm. This will leave little to no doubt as to the current market value of your company and can be used for other purposes in the immediate future.

Find Trusted Partners

It is difficult to go through an acquisition by yourself, so make plans to identify trusted consultants who can assist you during the process. Business attorneys, appraisers, tax advisers, and investment bankers are some of the contacts you want to develop in advance of an acquisition. These partners can help you manage your expectations and take some of the burden off you while positioning your business for a successful sale.

Complete Your Own Due Diligence

While third parties can help you understand the market, you should consider doing your own research to better plan and understand the strengths and weaknesses of your company. Review recent transactions in your industry and identify trends. Try to determine the best type of company to acquire your business as a stand-alone operation or part of a larger firm.

Get Stakeholders and Employees on Board

While you may be ready to sell, not all company personnel and current investors will understand the decision. The process will run smoother if you communicate clearly to all parties affected by the transaction. Personnel and clients are part of the overall value of your business. By retaining these relationships going into the sale, you can avoid infighting that might sabotage the deal.

By taking these steps before an acquisition, you can properly position your company as the right fit for the acquisition firm, while navigating every step of the process with confidence and ease.

When you are trying to determine the overall value of your business, a certified appraisal is a great place to start. If you are a business owner, and your company’s stock is not traded publicly, it is considered a privately held concern. There are a few distinct variances between private and public company valuation methodologies. Understanding the potential approaches the appraiser will take to value your private company while using data from public businesses, is important as you work with them to develop a realistic and supportable value.

When private businesses are appraised, there are a number of approaches that are considered. For the majority of ongoing enterprises, the income and market approaches are measured and weighed to ultimately determine the most accurate value for your company. When the market approach is utilized, the business may be compared to a similar public company, while making adjustments that look to match the public company as closely as possible. The income approach will review historic and current revenues and expenses, in an effort to reasonably discount cash flows over a future earnings period.

There are other, deeper approaches the appraiser will consider as well, within the market and income methodologies.

Under the market approach, there is both a “Guideline Public Company Method” and a “Guideline Company Transactions Method” used for private businesses.

The first option reviews financial data that is freely available from similar publicly traded businesses. It considers the actual price investors would pay for a minority interest in the public company as the basis for the valuation. The public businesses targeted for comparison are typically in the same industry and market as the private company, with a similar business model.

The second “transactions” method may be considered if a public company has recently been sold which closely fits the structure of the private company, within the same business sector. Financial data may not be available, however, details of the sales transaction can be reviewed and weighed in the appraisal effort. Under the income approach, the “Multiple of Discretionary Earnings Method” and “Gross Revenue Multiple Method” are the two most commonly used for private companies.

Within the first of these, if your business is simply too small to compare to a public entity under the market guideline methods, this alternate approach might be more applicable. It looks solely at financial statements and adjusted earnings by deducting discretionary expenses from the bottom line of the typical public company model to create a reasonable multiple of adjusted earnings, which is then applied to your private business’s adjusted earnings.

Under the second income method, the gross revenue of a typical public company in your market is considered to estimate a multiple, which is then applied to your private company's revenue, to determine value. This method doesn't consider profitability, which may be a factor that will affect the appraisal.

Engaging with a certified business appraiser will start the process of valuing your private company and all of the potential methodologies considered in the process. The results will assist you in the potential sale of your company, or offer support when considering refinancing, new investment, updating company practices, and adapting to new markets.

Whether you own a small business or a conglomerate, many markets and industries have been significantly affected by the pandemic and more currently, the supply chain shortage, resulting in delays of transactions for a multitude of products and services. If your business model has been greatly altered as a result of these unprecedented times, and you are struggling to adapt to the shifting marketplace, consider obtaining a current business valuation to assist in measuring these changes, and developing a game plan for the future.

A certified business appraisal will also provide you a distinct advantage if you are considering buying, selling, refinancing, or taking advantage of available investment opportunities. The ability to manage your business efficiently and successfully, as the playing field changes around you, is critical to the long-term success of your enterprise.

In today’s challenging economy, understanding the true value of your business will allow you to better recognize and capitalize on opportunities ahead of your competitors. It will also help prevent you from making costly mistakes. Regardless of the situation you’re presently involved in, a certified business appraisal will help enable you to make the best decisions on a day-to-day or long-term basis.

The appraiser will walk you through the process and provide insight as to the information needed to measure the overall value of your company with past, present, and future scenarios considered. As you communicate and collaborate through the process, the business valuation expert will determine the best approaches to consider and ultimately weigh, during the appraisal process. Making the most out of an otherwise negative situation, and potentially capitalizing on opportunities in these difficult times, is part of the formula of the successful, and adaptable business owner.

When a business valuation is conducted for your firm, its assets will be considered in the overall value. If your business appraiser determines that a strict asset approach is relevant to the overall analysis, they will look to understand the market value of tangible items such as cash, receivables, inventory, machinery & equipment, buildings, and land.

If your business is in an active and operational condition, the value of its intangible assets will also be considered. These can include domain names, patents, copyrights, licenses, customer lists, client relationships, non-compete agreements with prior employees, a trained workforce, guaranteed contracts, leaseholds, and general goodwill.

These intangible assets are generally more challenging to estimate value for, as they are not typically itemized on your balance sheet, and need to be reviewed separately to determine a reasonable approach to appraising. The business appraiser will want to review as much internal data as you can make available so they can consider these intangibles as part of the revenue that continues to drive the business. It’s reasonable to look to carve out a value for these intangible assets based on their particular impact on the overall value of the business. The appraiser can provide guidelines to assist in developing historical data and potential growth in the company as a way to measure this in a finite manner.

>As an example, certain contracts and existing client relationships can likely be attributed directly to consistent and tangible revenue the company has experienced over the years. A newly signed contract may open a pathway to future growth that can be measured based on the terms of the deal.

In summary, when completing a business appraisal under an asset approach, it is important to measure the value of all the assets in the company, both tangible and intangible, to gain a complete perspective of the overall value for your business. Working with your appraiser to develop reasonable measurements to value these assets, will result in a credible and reliable outcome.

As we move closer to the “new normal” for business operations in the aftermath of COVID-19, there will be challenges that face both owners and their service providers as to how they adjust their thinking both short and long term. Some of these questions involve the following:

• Should our employees continue to work remotely or come back into the office?
• Will the effects on revenue, good or bad, continue, or was this a short-term blip that will disappear in the next year or so?
• If I want to sell or buy a business in this changing marketplace, what should I consider differently than before?
• How can I take advantage of new opportunities created out of the changing business model?

Regardless of what opportunities or challenges you face today, it makes sense to consider an updated business appraisal as part of the next steps in your ongoing process. It may be that as a potential buyer of a business affected by the pandemic, you see an opportunity to purchase at a distressed value with the plan to reorganize and create efficiencies that will turn the company around in the near future.

On the flip side, if you are compelled to sell your company in the next year, you may need to consider discounting the value of the business and provide seller-assisted financing as part of the negotiation to incentivize a potential purchaser.

Much of the decision-making needs to be weighed against how short or long term your timeline is with taking these next steps. If you have the time to wait out the aftereffects in the hope of normalization, that might make more sense than determining an immediate course of action with many industries still impacted by the pandemic. Not every business owner has this luxury, however, and the need to make sound decisions with several unknowns still out there may require the assistance and guidance of objective third parties that can provide additional perspective on the state of your company.

From a valuation perspective, your research should lead you to engage with a certified business appraiser, with the expertise and experience to determine your company’s current value. These appraisers may have differing opinions as to the factors that will affect value the most, based on their understanding of your financial data and the marketplace itself, so ensure you have preliminary discussions with them before you decide the best fit.

Speak with your accountant as well, who may be able to provide insights into the best approach to working with an appraiser. In summary, the challenges ahead may be many, so try to gather the support you need to make the most informed decisions possible as you navigate the “new normal”.

When you're considering having your business appraised, your research will likely lead you to the NACVA (National Association of Certified Valuators and Analysts), which provides a wide range of services, including certifications, for business appraisers. This designation can make a big difference when it's time to have a company appraisal performed. Here's a summary of what the NACVA is and how appraisers become certified.

Prior to the formation of NACVA, the methodologies used by these appraisers, accountants, and other business professionals followed a wide range of approaches and analyses. There was no consistency in these procedures which ultimately led to scrutiny and doubt as to the reasonableness, reliability, and independence of the conclusions. When audits were performed on a number of the businesses involved, it was determined that formal guidelines and procedures were needed to govern the valuation industry.

In 1990, the NACVA was founded to implement and support the business marketplace. It developed and tested methodologies for estimating business value under a wide range of circumstances. Over time, these methodologies were accepted in accounting, legal, insurance, financial, and tax circles, and were determined to provide the most accurate picture of business valuation. The NACVA has certified thousands of financial and accounting professionals, including CPAs and valuation specialists. The majority of that membership is certified in one of the Association's three main programs: Certified Valuation Analyst or CVA, Accredited in Business Appraisal Review or ABAR, or Master Analyst in Financial Forensics or MAFF.

The independence and consistency of the methodologies required to be considered and implemented in every appraisal under these guidelines have been critical to establishing a strong reputation of integrity. The business appraisal will also include insights into your company's performance and operations, strengths and weaknesses as well as the position within specific markets and industries you focus on.

Becoming a Certified Valuation Analyst within the NACVA involves a combination of education, experience, and formal testing, that takes years to earn. This designation gives the appraiser direct access to the resources of the association and requires them to follow the methodologies and approaches approved within. Continuing education is also a requirement to stay current with changes and updates to the program.

By being aware of what the NACVA is and how its certified appraisers can bring added value to your business, you can use that knowledge and the quality of their reports as leverage at the negotiating table. Working with a certified appraiser ensures that your business valuation has been determined using standardized methodologies that will stand up well to strong scrutiny in a wide range of areas, including legal, insurance, financial, and tax circles.

Whether you want to buy or sell a business, you need to know how much the company is truly worth. To understand this more accurately, you will need to engage in a formal independent business valuation, preferably completed by a certified appraiser. There are various approaches for determining value when performing a business appraisal, and the valuation professional can assist in understanding the best methodologies for the business involved. Here are some of the ways an appraisal is analyzed:

Market-Based Approach

For an active company, a market approach can be one approach that measures fair market value and overall position in a competitive environment. Within this approach, there are different methods to consider, including those for public and closely-held businesses, as well as basing it on a multiple of gross revenues or discretionary earnings. Depending on the specifics of the business, one or more of these approaches is utilized and weighed in the analysis

Income-Based Approach

An income perspective can be useful to value companies of all sizes and is particularly effective for firms that operate with a capital investment intensive structure. One method within this approach is the Discounted Cash Flow method, in which an appraiser gauges future revenue five years down the road, and discounts this to determine the present value and ultimately a fair sale price. This can be beneficial for companies that experience varying levels of cash flow and earnings each year.

A second method under the income approach is called Capitalization of Earnings and uses EBITDA (earnings before interest, taxes, depreciation, and amortization) to estimate a single point-in-time value for the company using its cash flow. This method can best work for operations that experience steadier cash flows and have demonstrated consistent growth.

Asset-Based Approach

This approach focuses primarily on the tangible assets of the business while making adjustments to the company’s book values and goodwill in an effort to estimate value for firms with high levels of capitalized investment, such as real estate machinery & equipment and personal property.

There are certain methods that can work best within this approach, with an initial focus on depreciated book values while adjusting for current market value using tangible asset appraisals to complement the business valuation

In summary, the business appraiser considers and weighs these approaches that factor tangible and intangible assets, revenues, profits, markets, industries, and all other relevant components into the equation, to reflect the overall value of the company. The appraiser may ultimately determine only one approach makes sense while in other instances utilizes several into the appraisal analysis to ensure the most reasonable conclusions.

If and when you start the process of selling your company, the determination of the right price is a critical component. How do you determine a reasonable figure that recognizes all the factors that make up value, including sales, profit margins, marketplace, industry, employees, capitalized investments, expenses, and all the hard work you have put into it over the years? What about the timing? Are you in a hurry to liquidate or do you have the luxury of waiting for several months or a year to find the right buyer?

Here are a few important considerations to take into account that will help get you started:

Don't just base your asking price on recent comparable sales in your local or regional area. Every business is different, regardless of its similarity to other companies. Yes, you should take time to review these as a possible source, however, there are likely differences to consider, including reputation, goodwill, number of years in operation, annual sales, location, and other factors that can affect the overall valuation of your particular business.

If you're thinking about selling your business within a short timeline, 60-90 days, for example, you likely won't be able to realize 100% of the fair value. You may need to settle for a lower price given the limited exposure in the market and less interest generated as a result. Unless you can afford to extend the marketing plan for a longer period, you will need to temper your expectations and adjust the price you are willing to accept in this scenario.

Is your business in a specialized market? How many potential competitors or investors in your industry can you think of that may have an interest in acquiring your company? This factor can work both for and against you. For example, if you are one of several similar businesses in your marketplace, you may be able to quickly find a potential buyer, however, the price level may not be as high or negotiable as you would like it, given the number of competitors. On the flip side, if you have a unique operation that only a few other companies may show an interest in nationwide, you can take advantage of the specific intangible value your business will bring to a buyer but it could be a more difficult negotiation trying to place a value on the many variables at play.

Regardless of where your company falls in this framework, it is important to obtain an independent business valuation to arm yourself with a supportable unbiased assessment you can disclose to buyers at the right time. This step should be taken as early as possible to better enable you to understand the right approach to setting a price to sell. A business appraisal also provides you with insights into your business, including areas that need improvement as well as the strengths that drive value. You may even want to take the time to make certain changes in company structure as a result of the valuation and then determine the right time to go to market. A business appraiser can also provide insights into the current market and industry, which may influence your timing and decision-making.

By considering these factors before entering the resale market, you can determine the best approach to selling your business at the right price.

The definition of a small business will vary depending on who you ask or where you research the term. Based on the number of employees, owners, investors, annual revenue, profit margins, and specific marketplace a company competes in, your operation may likely fall into this category. The fact is that the majority of companies today are considered small businesses, especially when compared to the conglomerates who have taken over large market shares in recent years.

The Small Business Administration (SBA) has a broad definition, which varies greatly based on the overall industry and company structure. This has benefited many who have worked with the SBA on start-up or refinancing opportunities, as well as the related services this organization provides to business owners. Regardless of the definition, if you're considering getting a company valuation as a small business owner, you're making a prudent decision to independently assess where you are today and preparing for the future.

One of the primary reasons small businesses need an appraisal is when considering a sale or change in ownership, such as a transfer to the next generation in the family. In this example, the departing owner wants to realize a fair value independently of any subjective opinion within the family. The relative taking over the business wants to be comfortable that they're not paying too much during the transfer. The formal valuation process creates an effective tool to help both sides realize a favorable outcome.

The appraisal process begins with a review of a company's finances while completing a questionnaire that provides the valuation professional with the data needed to consider the history and future plans of the company. The next steps involve reviewing the industry to determine how your company fits into the broader marketplace. Is it currently growing or stagnating? It's important to know how your company has been doing historically in the market, but also critical to look toward future long-term viability.

A small business appraisal is a valuable tool that can be used to improve your company's operation while gaining a realistic understanding of its current value. Ensure that you engage with a certified business valuation professional with at least 5-10 years of independent experience, so you can capitalize on their insights.