Business Valuation Blog | Understanding Buying / Selling a Company

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.

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.

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.

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.

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.

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:

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.

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.

When you are looking to get your business appraised, a common concern is how much it will cost. Perhaps a more important question is what kind of return on investment will you reasonably see from the valuation effort? A business appraisal gives you a great source of insight into your company’s financial state on many levels, from determining a need to expand into new markets, hiring new employees, reducing resources in certain areas, or generally setting new goals. If you are looking to buy or sell, a business valuation is an excellent source of information that will leverage your negotiating position.

As an investment tool, business appraisals can be used to determine where your company is financially at the present moment, and what the best course of action for your business would be. If you are considering a business expansion or looking to enter into a new market, a business valuation can assist with estimating the potential risk of new investment. It will help ensure you have a more robust financial picture thereby allowing you to make more fully informed decisions about the direction your company should go.

An appraisal can assist in obtaining traditional bank financing or new partner investment. It will also help when planning an upcoming change in ownership, from a family estate perspective or a majority share buyout. Having a business valuation completed by a certified appraiser provides documentation that is accepted for legal, financial, and governmental purposes. In short, there are numerous ways a business appraisal can assist you in your long and short-term plans.

As you can see, the cost of a business appraisal is not the important part of the equation. Whatever your business plans may be, a company valuation helps ensure that you are entering the process well aware of your financial situation along with the pros and cons you may be weighing in the decision-making process. We can assure you that at Business Valuation Specialists, we will provide a certified, supportable valuation at a very reasonable cost and we look forward to the opportunity to work with you.

When you've worked hard to position your business for expansion, it's difficult dealing with the likelihood that not everyone sees the potential growth right now, when you most need them to. If you need to get more today for your business' future plans, you need partners who can help you obtain everything you can in today’s market.

Valuing a rapidly growing company is a challenge, but well worth the effort when it's time to consider a new investment, or possibly merging with another operation. The same can be said for those looking to invest in or even purchase the business.

There are several reasons you see the potential for rapid growth in your company. New market expansion, increased product and service demand, higher commodity prices, and changes in your operating efficiencies are just a few. Whatever the reason, your company is growing, and you want to take advantage now. Where do you go to make that happen?

A common, less effective way is to simply discount the value of that growth over a short-term, fixed future period, ultimately dictating a lower than expected business value thus, receiving less consideration than you should. On the flip side, you may overestimate the growth rate, and over-leverage your position as the value is not supported by realistic growth expectations.

The best option is to hire an experienced, certified appraiser to perform a company valuation. One who has experience in your industry and with growing markets in general. But what does that appraiser base the company's value on? Here are a few areas they typically consider:

• Future Earnings: How much is the business forecast to earn over the next several years? If it's realistically and materially higher than in the past, it will be taken into consideration when determining current business value.
• Market Conditions: Is the market booming, with many businesses within that sector seeing strong returns? If so, how long is this trend expected to continue? Much like the housing bubble and the dot-com crash, trends may change, though strong companies that are well managed through may expect to see a stronger market share in future upswings.
• Innovation in the Industry: Is your business viewed as a leader in innovation or does it create the same basic products and services as every other company across the industry? If you have a history of innovation, it can be reasonably expected that your growing company will continue to see strong growth, supporting a higher value.
• Goodwill and Reputation: Does your business have a reputation for excellence in the industry? A strong reputation can make a huge difference between reliance on one-off sales or loyal, committed customers who come back for your services and products time and again.

The work you've put into your business to prepare for expansion and take advantage of opportunities as they've arisen deserves to be recognized and rewarded, and valuing a growing company is a great way to substantiate that effort. A certified business appraisal conducted by an experienced valuation professional lets you take advantage of these future earnings, allowing you to benefit today from the forecasted plans.