Business Valuation Blog | Understanding Buying / Selling a Company

As a majority owner or equal partner in your business, there may come a time when you need to settle a buyout request from another partner or investor who is opting out of their ownership interest. When this occurs, there are a few things to focus on that will impact the agreement and it is common to look for guidance and assistance, including the engagement of a certified valuation professional.

Does your company have an internally developed buy-in/buyout or another type of operating agreement that lays the groundwork for assessing value when these situations occur? Proactively handling these eventualities is never a bad idea and is quite common for rapidly growing businesses that are frequently looking for new investors to manage capital funding requirements and add value.

Is the partner or minority shareholder a key contributor to annual revenue? If so, is there a non-compete agreement in place to buffer the effects of this departure in the short term? If not, should the company be valued with the anticipated losses in sales or is there a mutually agreeable arrangement to replace the partner and offset this reduction?

If the investor is buying out of a minority interest, should discounts be applied to reflect the value of his or her shares in relation to majority ownership? This topic is commonly debated in valuation assignments where the shareholder may not have the same level of control as a larger investor, or it would be more difficult to attract a replacement given the lesser interest.

Given these variables may create a divide between the parties on the ultimate price to be paid with partner buyouts, a dispute may ensue which may drag out the process and even lead to litigation between the parties. Engaging with a certified professional business appraiser will provide an independent, unbiased assessment of value which will hopefully facilitate a fair settlement.

In any case, when a minority owner or partner opts to buy out, it may warrant the need to formally update the value of the business and associated shares so you and any remaining investors can better understand the overall current status of the company. The benefits of having an independent appraisal of your business and the underlying assets can go well beyond these immediate concerns such as assisting with future growth plans and reviewing your tax and accounting requirements.

When business appraisers value small to mid-size companies, the most common documents that are reviewed will include financial statements going back 3-5 years that track the company’s performance over its most recent history. This data should be indicative of past operational performance; however, the appraiser needs to carefully review what they see on paper with the business owner to fully understand the larger picture and potentially make adjustments in areas such as discretionary/variable expenses and officers’ compensation. This ultimately creates a true picture of the company’s assets, cash flows, and profitability.

As a business owner, this same type of practice should be undertaken internally every year or two so you can carefully review all aspects of the operation and determine where consistent trends appear while uncovering areas that may be more volatile. This way, you can make adjustments to correct deficiencies and further capitalize on the more successful sectors, to create an optimal working environment for the future.

For many business owners, a 5-10% improvement in areas such as market share, gross revenues, costs, and profitability can make a meaningful difference in overall performance. It might free up working capital to invest in sorely needed improvements to your office equipment or make the difference that enables you to hire a new employee to assist with a slow-moving operational area or to build up the sales force. You may determine this adjustment could make you appear more proactive and successful to a new investor or partner looking to come on board in the coming year.

Whatever the desired result, getting into the habit of digging deep into your company’s year-to-year performance to understand better what has been working well and what might need tweaking, is a great practice to initiate, especially for owners looking to get that extra edge over their competitors. This is one example that can create an opportunity to be the best at what you do and allow for continued growth and success.

A few times each year, I like to discuss future planning strategies and long-term growth with business owners, and how they look ahead while keeping one eye on past successes and failures. Oftentimes, forward-thinking involves the potential for expanding the company, however, what if your firm is at the point where everything is running smoothly with revenues and net income right where they should be?

There may come a point when forecasting over the next few years involves simply keeping the structure of the company the same while making minor tweaks to refine existing strategies that will potentially improve margins. Is this an example of resting on your laurels or has all the hard work in the past finally reached a point where major changes are not economically feasible? Perhaps you are even risk-averse to future growth since diminishing returns would be a likely outcome.

This type of strategy may be more common than you think. Being a successful business owner does not always equate to having the compulsion to constantly reinvent the wheel. In fact, many experienced entrepreneurs in niche markets understand that once you have reached a certain level of market share, you have essentially positioned the company at the ideal point where current revenues, overhead, and profits are at optimal levels.

Depending on your overall personality, current drive, and where you are in your career path, it may be the perfect time to enjoy the fact that the business is exactly where you planned it to be years ago and consider whether you want to take a breath while reaping the rewards or move onto another opportunity. You have options in front of you, even though they may not be the same ones that got you where you are today.

Looking inward and reviewing how best to maximize the benefits of your existing employees and client relationships while fine-tuning a business that now needs only minimal maintenance are things you can do regularly. After all the challenges you’ve faced and past successes you accomplished, that is a great way to keep your company optimized.

As a business valuation professional, oftentimes your work effort goes beyond the preparation of an appraisal report. Business owners may engage with a more comprehensive advisory team to accomplish their goals, including tax, accounting, and legal representatives. With the potential threat of audits and legal disputes involved with certain ongoing project requirements, this team of experts may all have a role in the successful outcome for your client.

As the valuation professional, ensure that you include a clear delineation of the scope of work and fees associated with preparing and delivering the appraisal report and any follow-up consulting work which may arise as the transactions or cases develop. One option to accomplish this is to have a fixed cost for your initial report and hourly rates specified for any work pertaining to the continuing efforts related to the larger advisory team.

If you know the valuation work will be included as part of an ongoing or potential audit, or if litigation consulting and testimony may be involved, discuss these issues with the client and other members of the advisory team, so you can gauge the depth of additional time involved and look to better plan the future scope of work.

Ensure you document all your discussions, both by phone and email, while tracking your time on a weekly or monthly basis so you can support the additional costs involved with the prolongation of the appraisal engagement.

Look to these kinds of projects as an excellent tool to gain additional experience while working within a team environment where a common goal is to bring value added to your client’s transaction or legal case. Better understand the larger perspective of the matter so you can best prepare and potentially bring thoughtful suggestions to the table which relate to your role in the scope of work effort.

The most successful service providers understand how to look outside of their day-to-day analysis and report responsibilities and develop expanded opportunities in a business consulting and support environment. In a professional world where disputes are common and must eventually be ironed out, you can leverage your expertise to involve yourself in these cases and become a more diversified appraisal firm.

We all know about new year’s resolutions from a personal perspective, along with the challenges these can bring in accomplishing them both in the short and long term. One of the hardest things for many of us, in both our day-to-day lives, and as business professionals, is examining the things we don’t do very well, and changing our habits permanently, to create a more successful outcome.

As a small business owner, you may feel even more invested in making these course corrections for your company each year as you assess past achievements and look to improve areas where results were less than optimal. This behavior is part of the core foundation of a long-term growth strategy that keeps your business operating as efficiently and effectively as possible. As the larger industry and marketplace, you work in changes over time, you need to keep up and adjust for these external issues. Also, review your internal structure and processes and determine whether there is room for improvement in any areas that drive revenue and control overhead and variable expenses.

Consider who on your team has outperformed expectations and how they might help take your business to the next level by promoting them or expanding their responsibilities. Keep an eye on employees who may be going in the opposite direction and determine if you can bring them back into the right mindset or potentially need to find alternatives for their role in the company.

Even if you had a very successful year in 2022, it is prudent to refresh your outlook on how the operation functions, while continuing to improve and create further growth opportunities. The concept of “if it ain’t broke, don’t fix it” doesn’t apply in situations where change occurs, both within and outside of your control, in the business marketplace, and right at your doorstep.

Seek to obtain advice from key advisors and employees who you trust and work with on a year-to-year basis. Objective opinions outside of your own experience are always useful to potentially view things from different perspectives before you fully commit to a course of action.

Give yourself the opportunity to look back at 2023, a year from now, and tell yourself you did everything you could to continue to create the best version of your company. Every objective may or may not be accomplished, however, putting in the effort to carefully consider all the options to remain successful, and continue to grow, will be rewarding.

Each company within every industry has certain key factors that determine and drive the success of the operation. It is therefore important to take a deep dive into yours and understand exactly what those variables are so you can continue to maximize the positive impact these have on revenues, costs of goods sold and operating expenses.

What parts of your business are making the biggest difference to your bottom line?

Consider the following:

• Marketing variables such as website optimization, social media messaging, or a strong sales team.
• Unique product offerings that may create higher margins than your competitors and allow you to provide customers with better pricing.
• Client communications that are consistent and effective.
• Commitment to timely delivery of your products and services.
• A strong market reputation based on decades of experience, expertise, and proven results.

It might be a combination of these variables or something even more distinctive that creates the value added that separates your business from all others in your industry and specific market niche.

Once you, as the business owner or executive, have a good understanding of what these factors are, you can discuss them in detail with service providers and consultants such as your accountants, financial institutions, and investment advisors. You can also share them with outside consultants such as business appraisal professionals and brokers who will work with you closely to develop the documentation necessary to exhibit the level of financial value your company truly supports.

Some key variables may not be readily apparent on balance sheets and financial statements so it is vital to create a way to break down the numbers further and make adjustments that can be supported in a more detailed analysis. By carefully explaining all these factors to those who will, in turn, independently and reasonably verify them, you will afford yourself the best chance to translate them in a more tangible way that will be obvious to those who will take an interest in your business down the road.

For those tireless small business owners whose hard work and good fortune have enabled them to build a profitable, growing company, it might be time to consider how best to “share the wealth” and develop beneficial plans for your employees while accessing profits to accelerate your retirement planning. Here are a couple of thoughts to get you moving in the right direction:

401K Plan

Many of us have previously worked in a larger organization where 401K plans were available as part of a benefits package. Setting aside a percentage of your paycheck on a pre-tax basis that diverts to an investment retirement account is a sound future plan for many employees. Certain corporations will match the employee contribution up to a certain amount, typically 3-6%, providing additional advantages to the plan.

Why not set this up in your small business? This will benefit both the business owner and current employees while improving the attractiveness of your company to potential new hires.

Employee Profit-Sharing Plan

A profit-sharing plan can create a significant benefit for both the business owner and their current staff and provide additional assistance in retirement planning. These plans act like deferred annual bonuses for the employees while enabling the business owner to deduct profits on a pre-tax basis as a bottom-line expense to the business.

Similar to the 401K plan, these funds act as a longer-term investment. For employees, there is usually a vesting period that accrues every year, creating an incentive to stay with their employer until the account is fully vested. 20% annual vesting is common, creating a five-year timeline before the funds are 100% accrued.

Combined Plans

Creating a multi-level investment plan for you and your employees can create even more advantages for those who participate. For example, combining a 401K with a profit-sharing plan may allow the business owner to realize a maximum level of pre-tax income benefits allowable under the tax laws. Once you have committed to developing these kinds of ideas internally, you should contact your financial advisors who will take you through the detailed steps involved in creating and enacting these plans, while explaining how best to structure them for your specific business. This can be a complicated process so make sure you fully understand all the pros and cons involved before formalizing.

Many small business owners often wonder what their company is actually worth when they review each year’s performance results, growth patterns, and future outlook. Why not take this process a step further and definitively determine the overall value of your business?

You may answer this by claiming there is no benefit to having a formal appraisal completed until you absolutely have to. If there is no requirement such as for bank/SBA financing, new investor buy-in, partner dissolution, sale of the business, or other ownership shifting events, then is it really necessary? Won’t it require a lot of extra time and effort I don’t have? Isn’t it expensive?

The answers might surprise you. Working annually with a certified business appraiser can become a seamless part of your regular tax accounting processes and provide additional backup to your financial statements in the event any internal or external third parties ever want to review them with you. Minority partners, shareholders, key employees, new investors, banks, tax authorities, and others may knock on your door one day and ask about the state of the business.

Having an annual appraisal to complement the rest of your data will go a long way to efficiently address these issues. If an insurance, compliance, or tax audit is required down the road, you will be several steps ahead toward resolving these as painlessly as possible.

From an expense perspective, the cost will vary depending on the size and complexity of your business, however, you should be able to find a reputable valuation firm that understands your business and has the experience to provide a reasonable fee level in line with your expectations. Committing to an annual review and update with your valuation professional may enable you to receive some type of discount on future appraisal work.

Ensure you engage with a certified, experienced appraiser who will provide a high level of service and integrity with their work product. There are a handful of inexperienced and disreputable companies in the marketplace offering cut-rate prices, so be sure to research your options before you make a decision based solely on cost.

In summary, the overall value of having an annual business appraisal completed in tandem with your normal accounting and tax filings far outweighs the incremental costs involved. Planning ahead is always a good practice to instill in your business, so you will always be prepared for whatever may happen in the future.

As a small business owner, there will be times when third-party consulting services become a necessity in order for you to complete certain goals and accomplish plans made earlier in the year which are now becoming a more immediate concern. Whether that’s refinancing your debt, obtaining new working capital, buying out or adding partners, updating stock value, or any similar internal planning, there is usually a requirement to seek independent advice and reports to eliminate potential bias.

Engaging with a qualified business appraiser should be at the top of this list of external advisors given that their reports will be relevant in virtually all of these potential scenarios. Like everything involved in day-to-day operations, you want these longer-term projects to go as smoothly as possible and have an optimal outcome. What are some of the ways to increase the chance of this happening?

Start the Process Early

As with most business decisions, the longer you put them off, the less care and planning will be involved during the process. These goals may take months to complete so the earlier you start to take initial steps, the more time you will have to effectively work it from start to finish.

Ask For Advice

When working with valuation professionals or any other type of consultant, take advantage of their experience and expertise by asking a lot of questions. These advisors have been involved with hundreds of similar projects and can offer thoughtful advice on how best to work through the transaction.

Utilize Internal Resources

Whether it’s your company accountant, controller, finance manager, or other senior employees who may provide insight and another pair of hands, consider bringing them into the fold as part of your team to manage this project. Don’t take everything on yourself unless you have no other choice.

Provide Full Disclosure and Be Completely Honest

Have the advisors sign an NDA (Non-Disclosure Agreement) so you are comfortable sharing internal reporting documentation. Work with the consultants to break down these statements into a more realistic picture of your cash flow and growth potential. Don’t be afraid to discuss the true picture of your company’s finances as opposed to what might be limited to accounting or tax reports.

In summary, as a business owner, you are the expert when it comes to describing the history and future plans of the business. Getting the most out of your internal team as well as the independent advisors you engage will give you the best chance of an optimal outcome for these longer-term goals.

Business appraisers typically gather a lot of historical financial data when working with their clients on valuation assignments. They review income statements and balance sheets while looking at the market and industry data that all help shape their conclusions. Going back five or more years is not uncommon, while at the same time discussing reasonable future expectations within the confines of the current company profile.

On occasion, however, an appraiser may engage with a new “startup” or a company that’s been in development for years with little to no income that projects a formidable 5-year forecast of significantly higher revenues. How should that appraiser approach the valuation effort without ignoring historic performance or the external data they usually rely on when looking at more traditional businesses?

The answer is largely dependent on the credibility of the forecasted revenues and their client’s underlying reasoning behind these estimated projections. Here are a few questions to ask both the client and yourself as you work through the analysis:

Is the business unique in any way to its competitors or to comparable businesses in the market?

If yes, then it makes sense to focus on those areas to support the projections that might otherwise appear unreasonable on the surface. If the answer is no, then use the available market to create some checks and balances with the forecasted figures.

Has there been any tangible infrastructure developed within the company that sets the stage for realistic expectations of the longer-term forecasted growth?

It is common with a 5-year forecasted projection to aggressively estimate much higher revenues in the latter half of this period. What has been accomplished today that might further enable the appraiser to agree the longer-term outlook is not overreaching?

What degree of hypothetical or extraordinary assumptions is being made to support the aggressive growth?

Is the client making one too many assumptions about the internal structure of the company or making future market predictions that just don’t add up to a reasonable expectation?

Overall, there will be additional challenges with these valuation projects where reliance on heavily forecasted projections far outweigh historic data. As an appraiser, don’t be afraid to question the client if you are not comfortable with the overall picture they are presenting. Have them provide a clear, sensible outline that supports the aggressive forecasts, and ensure you make statements in your report which show the level of reliance you put on the assumptions and conditions. After all, it is your work that will potentially be relied upon by other parties who may be investing in the future of your client’s company.