Business Valuation Blog | Understanding Buying / Selling a Company

Business Valuation: EBITDA vs. SDE to Measure Profitability

Posted by Business Valuation Specialists LLC on Aug 26, 2024 7:30:00 AM

Business appraiser calculating EBITDA and SDE

EBITDA and SDE are the two drivers behind valuing a business under the Direct Market Data Methodology, using a company's profitability and cash flow while factoring in market-based multiples that apply to these figures.

What is EBITDA and SDE?

EBITDA is an acronym for Earnings Before Interest, Taxes, Depreciation, and Amortization, while SDE stands for Sellers Discretionary Earnings.

EBITDA looks at a company's reported net income and adds back the components listed above. SDE adds back variables such as the owner's salary, non-cash and one-time expenses, interest on debt and non-operating expenses.

Other adjustments may be made to these figures based on the particular business and how the owners account for certain expenses and compensation. Under this approach, a market-based multiple is then applied to these calculations to estimate value.

It is uncommon for an appraiser to estimate value using both EBITDA and SDE, so which of these should be relied upon when valuing a business? This is typically determined based on the size of the company and its net income level. The other consideration relates to the involvement of and reliance on the owner to run the operation.

For example, suppose a small business has a net income under $1,000,000 annually and is heavily reliant on the owner's involvement. In that case, SDE should be the measure, given that owner compensation is a major component when adjusting profitability.

On the other hand, with larger companies with net incomes higher than $1,000,000 and the owner's role being less critical to running the business, EBITDA should be the focus. If the owner already has a management team in place, there is no need to rely on the owner's compensation as part of the earnings adjustment.

As a result, EBITDA will typically be less than SDE, and the multiples applied are higher than SDE, given that the prospective new owner will not have to work full-time to run the company successfully.

In summary, once the business appraiser understands the company's structure and net income history, they can make a sound decision about whether to rely on EBITDA or SDE when valuing your business.

Tags: Business Appraiser, SDE, EBIDTA

Don’t Expect Appraisal Experts to Be Industry Experts

Posted by Business Valuation Specialists LLC on Jul 29, 2024 7:30:00 AM

Professional Appraisers Value All Types of Businesses

When potential new clients inquire about our valuation services, we are often asked how much experience we have in a particular industry. The fact is that an appraisal expert cannot focus a significant amount of time on any one industry if they want to maintain steady revenue and grow their business. There are nearly 100 major industries in which companies operate, and appraisers need to apply their skills to any or all of them to create a diverse valuation practice effectively.

Appraisers go where the opportunities take them, regardless of the industry in which their clients operate. Fortunately, if a professional valuation expert has been working for a long time, they have likely completed a certain number of appraisals in several different industries, which increases the odds they have experience in the ones they are being asked about.

Clients need to understand the distinction between industry and valuation expertise. They are two very different functions that will sometimes intersect but primarily demand professionals to focus on one or the other. As an appraiser, I find it fairly simple to develop an aggressive learning curve when working on projects within any of these industries. Combining the market research they conduct for each project and direct client communications will allow them to understand better what they need from an industry perspective to complete an effective valuation.

The standards and methodologies learned and employed by certified and accredited appraisers apply to every industry they work in. All the educational time, effort, and application of these accepted approaches are consistent for any company being valued. The more experience a valuation expert has will further reinforce the understanding that employing these methods in every project they complete will provide greater support and credibility to their analysis and reporting process.

It is important to comprehend the nuances of the industry you are valuing. There are databases and market sources that provide this kind of information at the fingertips of any appraiser who knows where to look. This data will influence the valuation conclusions and is typically based on a considerable number of comparable companies within the same industry.

In the end, regardless of the level of experience an appraiser has in any particular industry, they will be able to provide a credible and dependable valuation of your business if they hold the proper credentials that make them experts in the appraisal industry.

Tags: Business Appraiser, certified appraisal

Expert Witness Testimony in Valuation

Posted by Business Valuation Specialists LLC on Mar 25, 2024 7:30:00 AM

Business Appraiser Expert Witness Testimony

One of the most challenging components of a professional appraiser’s practice is being an expert witness in a court trial, hearing, deposition, or arbitration. Regardless of how many years of experience an appraiser has, or how many times they have testified, this can be a very difficult process to go through.

Many accredited, professional appraisers rely on business and personal dispute work as part of their overall revenue, and, commonly, a significant percentage of their work involves clients who have hired attorneys to represent them in a litigation matter. The importance of providing an independent, unbiased, opinion of value is critical when business disputes arise, as damage and liability claims need to be reasonably determined. With difficult partner buyouts and divorce cases, there are rare circumstances where a fair division of assets during a separation can be negotiated without the need for a third-party valuation.

Based on my own experience, on average, 35-40% of our engagements involve these kinds of cases. Fortunately, once the initial work has been completed and reports delivered, many of them settle before formal hearings take place. There are, however, those cases that do not, and testimony becomes inevitable.

Since the pandemic, the courts have been trying to catch up with a lot of older casework, while business and personal disputes have accelerated since the recovery. I have testified more in the last 3 years than I have in the 10 years prior, and there is no slowdown in sight.

Fortunately, there have been a few efficiency improvements in the process, the most important of which has been the ability to testify remotely. The additional time and expense involved with traveling has been eliminated in most cases, which benefits all parties involved. The reduced stress that goes along with the travel component of being an expert witness is also a boon to professional appraisers.

Based on my experience, and in discussing this topic with attorneys, I believe the efficiencies involved with remote testimony have not lessened the effectiveness of the process, which leads me to believe this alternative will be around for the foreseeable future.

Regardless, testifying as an expert witness will always be a challenge for valuation experts. There are courses available to appraisers that assist with understanding the process, developing strategies, and gaining key insights to be more effective, however, no matter how many classes you take, or how many times you testify, you will probably always feel like you could have worded something a little differently in a certain part of the testimony. Appraisers should take as much as they can from each experience and strive to become more adept for the next one.

Tags: Business Appraiser, expert witness

Be Proactive: Don’t Wait for a Reason to Value Your Business

Posted by Business Valuation Specialists LLC on Jan 3, 2024 7:30:00 AM

small business owner needs valuation by appraiser

With 2024 in mind, many of us vow to change a habit or two and get a fresh start on improving our way of life with the proverbial New Year's Resolution. This change in mindset can often be fleeting when the thought process does not materialize into instant benefits after minimal dedicated work effort. The brain can quickly adjust back to telling you that everything is fine, and you feel pretty good about yourself.

The same can be said for your business where it is much simpler to continue with the old way of doing things, especially when the year-to-year results are solid, and you and your staff seem content with current operations. There might not be any reason to overhaul your business model, however, you can always be more proactive in looking ahead and tweaking a couple of things based on recent experiences and increased knowledge.

One of these adjustments should involve not waiting for a reason to take a concrete look at your company and establish a baseline value, so you can better measure the real worth of all the effort you’ve put behind it over these past years and create a tool that can monitor progress in the future. Obtaining an independent, professional appraisal of your business is always a good idea, regardless of what might otherwise force the need to complete one as part of a pending transaction.

Most business owners wait until they absolutely need to have a valuation done, in complement to such things as bringing in or buying out a partner, a personal divorce, or refinancing debt to obtain working capital. As a result, there is a sudden rush to get it completed, and the added pressure of working through the process can further stress an already time-consuming and tedious situation.

If you have already recently completed a valuation, while using an experienced, accredited appraiser, it is simply a matter of sharing this report with the appropriate parties and immediately checking the box for this requirement. Advising your valuation expert that the purpose is for “internal business planning” will allow you to utilize the report for most of these future developments. Getting into the habit of updating the business valuation annually will make it more certain that the results are current and will be sufficient for any third party to review and consider as part of the larger transaction.

Being proactive is generally considered a benefit in your day-to-day life. Having a similar game plan when it comes to your business is just as important, if not more critical when it comes to continued success.

Tags: Business Appraiser, value of a business, small business valuation, business owners

Valuations for Divorce Purposes-Avoid Getting in the Middle

Posted by Business Valuation Specialists LLC on Dec 18, 2023 7:30:00 AM

Divorce case Business Valuation Appraiser

As certified, professional business appraisers, we engage with quite a few clients and their attorneys who are going through a marriage dissolution/divorce and need to value a business owned by one or by both parties involved. The workflow process should not be much unlike any other type of valuation; however, the potential “drama” that often occurs during divorce proceedings can sometimes bleed into the ongoing communication.

If this happens, it is important to take a step back and reaffirm how the appraisal agreement is structured, and who your client is. As a rule of thumb, never allow yourself to be dragged into any disputes between the two parties that play out during your involvement with the case. Remember that you have been hired to act as an independent service provider who is there to facilitate part of the divorce settlement by providing an unbiased opinion. You have no personal or professional investment beyond this scope of work.

If your client is one of the ex-spouses and/or their attorney, all communications should be with these parties only. If representatives from the other side contact you looking for information, you should advise them that all comments or inquiries be made to your client directly, and kindly request they not to contact you further. Immediately notify your client of the situation and ask them to intervene and gain control over it.

Even if your client does not own the business, they are the ones who will need to obtain the necessary documentation required to complete the appraisal from the party that does. Even in rare cases where the divorce is amicable and both sides cooperate fully, you should ensure all communication and data come from your client only.

Another scenario would be a co-client agreement, where you now have to deal with both sides agreeing to the valuation, signing, and paying their share of the fee. This may be a court-mandated arrangement, and working through this process will likely be even more delicate. You will have to carefully manage communications with both parties and possibly their attornies without getting caught up in the residual emotions and disagreements.

You may want to avoid these types of engagements altogether given the amount of management they will likely require; however, if you do find yourself in this scenario, consider organizing a joint call or email with clear instructions on how you plan to handle the process flow. There is added responsibility on your part, and you will need to develop a streamlined way of getting the requisite information to complete the appraisal.

Either way, working through a business appraisal for divorce purposes will always have the potential of being a uniquely challenging project.

Tags: Business Valuation, Business Appraiser, divorce

Business Appraisals for Divorce Mediation and Litigation Support

Posted by Business Valuation Specialists LLC on Sep 11, 2023 7:30:00 AM

Business Valuation in Divorce Dispute

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.

Tags: Business Appraiser, business appraisal, divorce

The 3 Approaches and Most Commonly Used Methods of Business Valuation

Posted by Business Valuation Specialists LLC on Aug 14, 2023 7:30:00 AM

methods and approaches to small business valuation

A Business Appraisal relies on three broadly accepted approaches that consider all the potential variables that factor into a valuation: The Income Approach, Market Approach, and Asset Approach.

These approaches review and analyze historic performance, reasonable growth projections, and the underlying assets of a company to estimate value. Depending on the circumstances, one or all three will be weighed in the final assessment.

Within these three approaches, there are a multitude of methods by which business value can be measured, however, when appraising a small privately owned company, there are typically only three methods utilized. Here is a brief summary of each:

The Capitalization of Earnings Method under the Income Approach

This method looks at the future projected growth of a business where historic revenues can reasonably predict ongoing trends over the next few years. Future cash flows are discounted back to the present date of the appraisal to establish value on a current basis. This method is most appropriate when a small business has shown a relatively steady level of revenue and income over the last 3-5+ years.

The Direct Merger and Acquisition Method under the Market Approach

This method estimates the prices paid for closely held companies that are in a similar line of business and can be considered comparable. Based on the data available in the market, it develops multiples that can be applied to the gross revenue and discretionary earnings of the business being appraised.

The Adjusted Net Asset Method under the Asset Approach

This method reviews all the tangible assets in the company, including real property, equipment, F&E, and inventory. Estimates are ideally based on an assessment of market value, or if that is not available, net book value. It also factors in cash, receivables, and liabilities to realize a net asset value. This method can be applicable if a business is capital-intensive but not producing a lot of revenue or net income, while also being appropriate for a company that is winding down operations.

In summary, you can discuss these methods in more detail with a certified valuation professional to better qualify which approach would likely apply to your small business. Taking the steps necessary to understand these approaches and methods before committing to a business appraisal will help you avoid any unexpected surprises.

Tags: Business Appraiser, certified appraisal, small business valuation methods, Business Valuation Methodologies

Review Opinion Letters: How They Differ from Full Valuation Reporting

Posted by Business Valuation Specialists LLC on Jul 31, 2023 7:30:00 AM

Review Opinion Letters in Business Valuation

Occasionally, appraisers are asked to provide opinion letters based on a review of another appraiser’s work product or from a company’s internal analysis for which they need independent validation. This process can seem more simple and informal than a typical valuation project, however, the time involved with completing the effort can be as much or even more than an appraisal.

Those businesses looking for a less expensive and time-consuming alternative to a complete appraisal will find the result can often be the opposite. Reviewing third-party work and commenting on their opinions and estimates for reasonableness, creates a two-fold process that can be more complicated than reviewing financial and asset data while estimating value.

At the very least, the appraiser needs to complete a high-level valuation of their own in order to comment on whether third-party opinions make sense or not. In many cases, the analysis required to provide a supportable opinion of another’s work product involves a similar amount or even more work compared with simply providing an independent appraisal of their own.

Opinion letters typically need to be generated from scratch given each project is unique and the requested deliverable will change with each engagement. With standard appraisal reports, most valuation professionals rely on a boilerplate framework that provides a more efficient way in which to develop their narrative summary.

Another issue with requests for review opinion letters is that many certified and accredited valuation professionals are not comfortable providing this type of report. The need to go outside the lines of their normal framework may create too many inconsistencies with the formal appraisal practice requirements that are adhered to in the normal course of business.

“Informal” is not a word appraisers like to use when providing opinions given the uniform standards they must commit to in their profession.

Typically, it will make more sense to have the appraiser complete their own analysis and valuation report which can then be compared to the other party’s work effort. This may seem repetitive and more costly; however, you may be surprised at the additional benefits you will reap when your auditors have an easier time approving the total work product. And there is a high likelihood that the time and cost involved will be very similar or even less when you ask for a more straightforward scope of work to complete the task at hand.

Tags: Business Appraiser, business valuation report, review, opinion

A Multitude of Reasons to Obtain an Updated Business Appraisal

Posted by Business Valuation Specialists LLC on Jul 17, 2023 7:30:00 AM

Reasons for Business Appraisals

Determining if you need to engage with an independent professional business appraiser will commonly arise when you are looking to purchase or sell a business. However, the fact is there are several other reasons an objective third-party appraisal is a great idea, and quite possibly a requirement to move forward with a transaction or to aid in a situation where a dispute may arise. Here are some examples:

Investor Buy-In or Buy-Out: You will look to have a fair assessment of company value determined to avoid a dispute and support a smooth transition.

Bank (Re)Financing: Virtually every bank or related lending institution will require an appraisal for loan purposes.

Litigation Support: Any legal disputes that bring your business into account will need an independent appraisal to facilitate a settlement or add support in a trial or arbitration.

Accounting and Tax Purposes: There are any number of reasons you will need appraisal work to aid in the review and approval of accounting and tax procedures.

Estate Settlement: When a family member passes and they own a business, a valuation will be an important component to transferring the property.

Development of a Family Trust and Legacy Transfer: When the next generation is ready to step in and take over the family business, an appraisal will be critical to the process.

Donation and Gift Tax: Some business owners may decide to donate their business or extend financial gifts through it. The IRS will require an independent valuation in support of the donated amount for tax deduction purposes.

Internal Business Planning: Looking ahead with long-term company goals from a growth and resource perspective will be much more effective with an appraisal assessment in support of project planning.

Divorce: If changes to your personal life include a divorce, your business, and personal property may become subject to the settlement.

If you find yourself involved with any of these situations, consider engaging with an independent, certified business appraiser to assist in facilitating the process.

Tags: Business Valuation, Business Appraiser, reasons for business valuations

Comparing Valuation Experience and Industry Expertise

Posted by Business Valuation Specialists LLC on Jun 5, 2023 7:30:00 AM

Business Valuation Appraisal Professionals Appraisers

As valuation professionals, you probably get asked about your expertise in certain industries when bidding on new appraisal projects. This is a reasonable question to receive from potential clients looking to engage with the most qualified candidates, however, your response should be both an honest and thoughtful one, focusing on the realities of industry experience.

The vast majority of certified and accredited appraisers, whether they specialize in business valuation, machinery & equipment, personal property, real estate, or any other discipline, cannot afford to limit their experience to a few specific industries, as this would severely reduce the number of opportunities for work and future growth of the business.

The fact is that companies who focus solely on valuation work and have the necessary credentials and experience as appraisers can effectively value properties across any and all existing industries and market segments. This is primarily because the continuing education and experience derived from working as a valuation professional is focused on implementing consistent and effective approaches and methodologies for appraising any company or asset, regardless of the industry. In addition, the appraiser will always rely, in part, on the specific market segment data and sources developed during the valuation process. Understanding how to research, review and analyze the market and industry data, while independently concluding on a reasonable value, is what separates the experienced appraiser from the rest of the pack.

There is a distinct difference between experience and expertise. As an appraiser, you may have years of experience valuing businesses within dozens of distinct industries, which is useful when potentially working in those same markets in the future, however, your expertise is in valuation and doesn’t need to be industry focused.

There are specific industry consultants who exist to assist their clients in any number of business decisions that can affect a company’s future success. For example, an oil and gas consultant might help their client enter a new energy market segment by developing a business plan that involves various marketing and investment strategies. That is generally where industry expertise comes into play. They may understand the concept of valuation and have certain opinions, however, they lack the training, experience, and expertise to effectively appraise that business.

In summary, it is important to advise your clients of these distinctions and the fact that your expertise is in valuation and not limited to any particular industry. An effective response can help explain that you will consider their specific market and industry as part of the overall appraisal while applying accepted, time-tested methodologies resulting in an independent, supportable conclusion of value.

Tags: Business Appraiser, Business Valuation Specialists