Business Valuation Blog | Understanding Buying / Selling a Company

Retirement can mean many different things to people who come from a multitude of family and career backgrounds. If yours involves owning a small business, there are some consistent mindsets and potential options ahead that are in tune with other proprietors nearing this phase of life. Here are a few to think about:

Keep it in the Family

If you’ve been fortunate enough to have one or more family members working with you over the years, there is the opportunity to sell the business while keeping it close to home. Consider who has the best makeup to take over the company, whether it be a sibling, child, or another relative who has been with you and knows the business inside and out.

Train Existing or New Employees For Replacement

One or more existing employees may have an interest in acquiring the business. If so, it may make sense to consider one or more of them under a buyout option. You may need to finance the acquisition in this case, either through a fixed loan or a percentage of the monthly revenue. If no one is senior enough to take over, consider looking outside for seasoned talent who can quickly learn the ropes and assume the leadership role.

Hire a Business Consultant for an Open Market Sale

There are experienced consultants who know your industry and could take a lot of the pressure off you while marketing your business to competitors and those looking to enter the market. This process may take several months, however, you can put the terms in place you’re comfortable with and negotiate a fair price with the support of reliable third parties.

Part-Time Transitioning

In any of these possible scenarios, it might make sense to consider a phase-out plan over a couple of years or so, in which you remain actively involved in the day-to-day operations on a part-time basis to ensure a smooth ownership transition, especially if you’re involved in the financing of the sale. It’s difficult for many small business owners to say goodbye to their company and the people they have worked with, so this might be a nice way to manage the process.

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.

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.

When it comes to determining the value of a company, many people, business owners included, consider only what the balance sheet says or what their local competitor sold for recently. But is that a valid way to determine what a business is truly worth? Not by a long shot. Here's our look at how professional business appraisers calculate the valuation of a company:

Behind Assets and Liabilities: How Professionals Determine Company Value

When a professional appraiser needs to determine the value of a company, the balance sheet approach is one of the last approaches used. Why? Because most businesses are far more than simply the sum of their assets minus the total of their liabilities. There are many factors, such as goodwill and reputation, position within the market and many other aspects that can affect the outcome of business appraisals. Here are two of the most commonly-used approaches to business valuations:

Income-Focused Valuation Methods

When a business is being bought or sold, the person who is selling the business is losing future income. For this reason, many businesses are appraised using an income-focused methodology that takes that income into account when determining the final value for the business. Two different methods are used to calculate the appraised value, specifically based on whether the company's income has remained steady or has been irregular in the past:

• The discounted earnings or discounted cash flow method is used when income has been irregular or periods of growth are irregular, and is used to determine the current value of future income.
• The capitalization of earnings method projects the steady growth of the past into the future to determine the current value of that income.

Market-Focused Valuation Methods

The market-focused approach takes into consideration what similar companies have sold for in the market, but customizes the sale figure to the business being appraised. The company used for the baseline may be a similar publicly-traded company or have similar transactions, earnings or revenues to the company being appraised. Common methods used include:

• The guideline public company method, which uses the price paid for minority shareholders in a similar public company in the industry and adjusts it to the company being appraised.
• The guideline company transactions method, which compares the sale price of companies that are of similar industries, size, location and products or services offered and makes adjustments to account for the differences between the sample company and the business being appraised.
• The multiple of discretionary earning method, which adjusts the financial statements from a small company by dividing the sample company's transaction value by its discretionary earnings, which is then used as a multiple for the company being appraised.
• The gross revenue multiple method, which is similar to the discretionary earning method in that it takes the transaction value but divides it by the sample company's gross revenue to develop a multiple for use in the company being appraised. This can be a poor choice if the sample company and the company being appraised are not similar in terms of profitability.

As you can see, there is much more involved in determining the value of a company than simple bookkeeping or real estate values can provide. The best way to ensure your company is receiving a quality business appraisal is by working with a certified business valuation specialist.