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.

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.

When you seek financing to purchase a business, it is typical that potential lenders will require an independent valuation to ensure the deal is sound. They want to confirm the sale price is reasonable and the business itself is financially viable, to mitigate the risks involved with the investment. Learn what it means to work with a reputable valuation firm to better understand this important part of the loan approval process.

Is a Valuation Required for a Business Loan?

Many lenders require that you have a company valuation performed by an appraiser. If your loan is backed by the Small Business Administration (SBA) or a similar government-backed program, they will often require an appraisal. SBA loans cannot exceed the appraised value of the business, inclusive of any real estate or equipment assets being acquired as part of the sale. Private bank lenders will have similar guidelines for business appraisals for financing approval.

As the buyer seeking the loan you should have additional money-raising plans in place, should the appraisal come in lower than the purchase price of the business. You can decide to raise the funds through private equity, use personal capital to make up the difference, or even go back to the seller and renegotiate the sale.

Ultimately, the appraisal protects your interests as a buyer, as well as the bank's interests as a lender. It may not make financial sense to purchase the business at a premium above what it’s worth unless you have ulterior reasons for doing so. For example, in a seller’s market, where there were other bidders involved in the sale process, or if you needed to acquire the business as part of a growth plan. Either way, it is better to understand the true market value of the business and have all financing options in place before you close the deal.

What Happens During the Business Appraisal Process?

The bank may select their own valuation firm to do the appraisal or have you select someone. In both cases, ensure the appraiser is certified, with sufficient training, knowledge, and experience to adequately complete the valuation. The appraiser will perform independent research on the business and review your documentation to estimate the worth of the company. They will rely on commonly used methodologies, such as the asset, income, and market approaches.

As the buyer, you will need to facilitate the process of working with the seller, lender, and appraiser to ensure the documentation needed is available and accurate based on your prior due diligence review. It is in the seller's interests that the appraisal meet their price too since they want the deal to close.

Once the valuation is completed, a report will be prepared and submitted to the lender, who will distribute the report to the appropriate parties. As a buyer, you should review the report to better understand the valuation of the business and its associated goodwill and tangible assets. You may also want to consider using the report to assist in insurance, tax, and accounting purposes.

In summary, you can rest assured that if an appraisal requirement coincides with you obtaining the best financing option for your new company, Business Valuation Specialists LLC will be there to guide you through the process efficiently and effectively.

When you're selling a business to a third party, the topic of appraisals may arise. But why is it important when you're selling your company, and what difference will it make at the end of the day? A formal valuation of your company is one of the key components that drive the transaction. Here's why:

Why Business Valuation is Important When Selling a Business to a Third Party

When you're planning to sell a business to someone you don't know, you want to make sure everything is done fairly and equitably. Completing an independent, certified, third party appraisal early on is the first step to ensuring this happens. By having an appraisal performed, you can see where your business needs improvement, and learn where it is already strong so that you don't have to put further effort into areas that are already in great shape. Once you've made changes and improvements in those areas that required them, your business should increase in value, allowing you to realize the benefit from your actions and detail these updates to potential buyers.

If you're like many business owners, you know that your company should be worth more than the assets on the balance sheet, but may not know exactly how much more. By having a certified business appraisal in hand, you have a better idea of what that figure should be, and can consider offers that are reasonable while dismissing those which are not. You can also decide if you want to ask a price that is in line with similar businesses in your market or if you feel you have a unique position that should be accounted for, ask something higher for that consideration.

Having a formal business valuation helps you at the negotiating table. Because a certified appraisal is based on accepted standardized methodologies, it represents best appraisal practices and procedures, and can also be useful in legal, insurance, and financial circles. If you want the potential buyer to come up in price, providing them with a copy of the appraisal report may make them aware of facts and circumstances about your business they may have previously been unaware of. This gives them a legitimate supportable reason to either change their initial offer or meet a counteroffer you've proposed to them during negotiations.

Business appraisals are vital to your success when selling a business to a third party. If you're getting ready to sell your business and haven't contacted a business valuation firm, please feel free to contact us today. Our qualified business appraisal specialists are ready to help you get the maximum benefit from your business sale.

If there's anything certain in business, it's that dealing with the government is probably going to take longer and be more complicated than you'd like. There are, however, several agencies that help small businesses, including the Small Business Administration (SBA) and the United States Department of Agriculture (USDA). These agencies offer popular loan programs with great rates and flexibility while working with your local banks to get you the financing you need to grow your business. Local banks oftentimes receive guarantees from the SBA and USDA that loans will be paid back to the lender if the business fails. For most of the loan programs, these federal agencies require a business valuation be performed as part of the approval process.

How can a business valuation help secure an SBA loan?

• A business valuation performed by a certified business appraiser ensures that the valuation has been performed independently with no bias while using accepted methodologies. This means that you will receive an accurate picture of your company's value and the SBA understands the loan they are guaranteeing is being measured against your company’s current worth.
• Business owners sometimes make the mistake of basing their company's value on tax accounting records. Though these documents are accurate and useful, they don't specifically reflect the appraised value of the business. A review and analysis of your tax returns and financial statements over a 3-5 year period will be better suited to properly value your business.
• Having an appraisal performed also helps you understand what condition your company is in. There won't be any surprises when you go to pay back the loan and realize there's an issue with your cash flow, industry position, expected income or similar concerns. You'll know where your company is strong and where it needs improvement. A business appraisal gives you a solid look at how your company is performing and where you need to invest more time and effort.
• SBA guidelines allow lenders to perform their own company valuation if a loan is for less than $250,000 but requires an independent certified appraisal if the loan is higher. You may want to complete a business valuation regardless if you believe the bank doesn't have a solid grasp of your business or industry and is limiting the loan terms, or you just decide it prudent for other business considerations.

By having a business appraisal performed on your company, you're doing more than just ticking off a box on a checklist, you're finding out valuable information about the health of your company's financial situation. Business Valuation Specialists is ready to help you.

It's no secret that small businesses are more flexible than larger companies, able to change production, focus, and market more quickly than their larger counterparts. With this change, though, as a small business owner, how do you ensure you're not exposing your enterprise to excessive risk that could cost you valuable revenue and profits?

Valuing a small business enables you to see into the nuts and bolts of where your company is strong and where it needs improvement, allowing you to manage risk more effectively to take advantage of opportunities as they become available.

Maximizing Flexibility

There's no doubt that the ability to nimbly change direction is one of the greatest advantages of small businesses over larger companies. However, changing direction requires that you know the condition of your business before commencing change. Will an evolution take advantage of market conditions or will a different business environment create growth for your company? Or conversely risk slowing it to a stop, even possibly putting it and everything you've worked for at risk?

To take maximum advantage of changes in your market, you need to know exactly where your business stands to determine where and when to make changes. One of the easiest ways to achieve this goal is by engaging a certified business appraiser to provide an updated valuation of your company.

Knowing Strengths and Weaknesses

How does the valuation of a company help you make it more flexible? All businesses, markets, and owners have different strengths and weaknesses. Knowing where your company lies through a small business valuation provides you with the information on whether an opportunity is a good one that plays to your strengths, or otherwise leaves you open to significant risk with the potential loss of market share. Business valuations are one of the best ways to determine where these strengths and weaknesses lay, whether it's in undervalued equipment, overvalued assets, or poor cash flow issues.

Reducing Risk

Valuing a small business allows you to know whether taking a particular approach to the market is a good idea or not. Business appraisals may help you determine whether your regional location has changed in market share, or what your expected business income may end up being when you've had inconsistent revenues and expenses in the past. You may be able to determine the change in your business is based on a recent boom in the market and if that boom is a short or long-term trend.

If you're considering a merger or partial sell-off to expand or reduce your business, will the new company reflect your strengths or pull it down by exposing weaknesses? By knowing where your company stands within the structure of a business valuation, you can make decisions that will leave you stronger instead of opening you up to needless risks.

By having your business valued by a certified appraiser, you can increase the chances of making good business decisions that will keep your company in the black and growing. Taking the time to have an appraisal performed gives you another tool and the added insight to help ensure you will be successful. If you need assistance finding a qualified business appraiser, please contact us today. At Business Valuation Specialists, our highly-qualified valuation specialists are waiting to help you succeed.

You are 55 and your employer of 15 years tells you that the company is going in another direction and your services are no longer needed. Suddenly, that six-figure salary you were receiving is gone. What are you going to do? Finding another well-paying job will not be easy and the thought of an extended job search is unappealing. Maybe you should create your own job and buy a business?

You are 30, in your prime, and ready to conquer the world. At work, you still feel like a small fish in a big sea. One day you realize that this is not the life you want so you give your notice in anticipation of something better. Buying a business will make you the big fish and gives you the opportunity to control your own destiny.

No matter what reason you may have for wanting to buy a business, you should take your time before making this decision and ultimately offering up a lot of money to purchase an existing business. First, ask yourself these questions:

• Are you sure you want to own your own business?
• How much time are you willing and able to devote to running it?
• Is the risk worth taking if it means giving up a high-paying job?
• How will it affect your family?

It is easy to get caught-up in the emotion and excitement of the moment and make hasty decisions. To be sure you are not paying too high of a price, and are getting into the right market, you should understand the real value of the company you are interested in purchasing.

A business appraisal provides you with a supportable estimate of the company's fair market value. It serves as a reference point for making an initial offer and makes it easier to negotiate a final sale price.

How are Business Appraisals Completed?

1. A business valuation starts with a conversation or communication with a business appraisal company. It provides an opportunity for you to give some basic information about your intended company to the appraiser who, in turn, will talk to you about the valuation process. You should feel comfortable that the company you are talking to has the expertise and experience to qualify as a certified business appraiser.
2. The next step is to get a quote for your company's valuation. The amount you are quoted is based on the things you discussed during your initial consultation. Among the things that can affect the amount of the quote are the size of your company, the detail of the appraisal, and the length of time it will take to complete the appraisal project.
3. Once you get the quote, you are under no obligation to have the appraisal done. You are not penalized for changing your mind. If you accept the quote and want to proceed, you will need to sign an engagement agreement which then commits you to the valuation effort to be put forth by the appraiser. In many cases, the current business owner will be willing to cover a share of the costs to complete the work.
4. You will then be asked to complete a business questionnaire and submit prior tax returns and/or financial statements. Most owners who are anxious to sell their business will provide the necessary documentation about their company so a company valuation can be done. If you express serious interest in buying a company, and the owner will not provide tax returns and other financial documentation, be suspicious. It may be an indication that the owner is asking more for the company is really worth.
5. Assuming that you are given access to the financial records of the company you are looking to acquire; the data and information is analyzed by the appraiser and a valuation report is generated. After receiving the report, you can discuss the results with your business appraiser.
6. You are now ready to make effective decisions and negotiate a reasonable sale of the company you may be running in the very near future.

When you're considering having a business appraisal completed, there are different options available. One option to consider is the discounted cash flow analysis, which is based on a company's income and growth by calculating the net present value that future cash flows will bring into a business.

How does a Discounted Cash Flow Analysis work in the Context of my Company’s Appraisal?

A discounted cash flow analysis looks at the expected future income, or cash flow, of a company over a reasonable time period. If your company is expected to have a particular percentage of growth based on a certain percentage of the business’ weighted average cost of capital (WACC) for a set period of time, the expected cash flow over that time period can be calculated. In essence, the estimated value of a company will rely on those forecast numbers to drive the appraisal. WACC is a recognized variable in every business based on the company’s debt and equity structure.

How Discounted Cash Flow Differs from Other Types of Valuation Methods

There are three approaches commonly used in business appraisals, (1) which involves strictly reviewing current assets; (2) a market driven approach; and (3) basing the appraisal on income. A discounted cash flow approach is based on an income assessment, however, taking it a step further, by not only including current income but projections about future income and the effect growth has on that figure. It often produces one of the higher value estimates for business valuations as it looks at what the company will do in the future, typically seen as a best-case scenario.

The Valuation Process Explained

The steps involved in this type of business appraisal include (1) Deciding how far out to forecast your valuation, (2) estimating the rate of revenue growth by calculating profits after taxes, working capital needs and estimated expenses, (3) calculating free cash flow based on previous figures, which can then be compared against current income statements and future operating costs based on the company's prior performance, and (4) calculating the discount rate.

Though it is acceptable to appraise your business off of past performance, doing so may not take into account potential changes to your company and future external economic effects. Some factors that help to better understand these are thinking about what the company's sector and its future development are as a whole, how well your own assets will hold up, and whether supply and demand pricing will remain the same.

There are different approaches to completing this analysis, and it is best left in the hands of an experienced appraiser to determine which one will best reflect future business performance.

In summary, a discounted cash flow valuation can seem overwhelming however, the results can provide benefits for your business in terms of projecting and recording market value today and in the years ahead. Working your way through this process will assist in discovering where your business’ future is headed.