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.

If you have owned a business for a number of years and now need an appraisal to sell the company, apply for financial assistance, or bring in new investors, you will need to have reliable financial documentation that provides historical performance details.

The most common records you will need are income statements, balance sheets, and tax filing records. You can provide further information by responding to a series of typical questions the valuation professional will ask during the process, that will give additional perspective on how to view these documents and make discretionary adjustments to the income and expenses of the business.

The appraiser will ask for 3-5 years of these filings, and they should be developed by an outside accounting agency or internal company controller. If you find yourself in a position where these records are not current, or poorly documented, you will need to determine the best way to update them, otherwise, the appraiser may not be able to assist you.

One option is to hire a forensic accountant or bookkeeper who can go through all the business receipts and related paperwork in an effort to develop formal documents which can be utilized for the appraisal as well as support these transactions. A potential buyer, financial institution, or investor is not going to blindly give you funding if the historical performance of the company is not well-detailed and documented.

Keep in mind the appraisal firm you engage with cannot actively participate in the development of these documents since they need to remain independent and unbiased when estimating their value opinions. As a business owner, you will know far more than anyone about the previous performance of the company as well as have access to the records needed to put these documents together. Whether you decide to take this project on yourself or work with an outside agency or internal employee, your direct involvement in the process will be critical.

Regardless of your immediate desire to put the business on the market, or look for new capital funding alternatives, take the time now to review your business records and determine if they are accurate and up to date. Even if they are, take further steps to organize a file to consolidate and provide easy access to, all the historical financial records of the company so that when the time comes, you will be prepared to move forward.

If you are unsure of the steps needed to complete this effort, contact a certified accountant or appraiser who can discuss the process further and give you informal advice that gets you on the right track.

We receive several valuation inquiries every year from companies still in their infancy stages that are looking to attract new investment through private equity or by bringing in additional partners with the right talent to help them achieve their goals. These “start-ups” are often thought to come from the various technology markets, however, anytime an entrepreneur begins the process of developing a business from scratch, regardless of the industry, they are considered a start-up.

With a start-up from a valuation perspective, you will not be able to rely on historic financial performance and the current balance sheet will likely be very limited. There will potentially be some comparable established companies publicly available to research, however, these may not be similar enough to rely upon given the specific business plan the new company is developing.

Most likely, your potential client is looking for the appraiser to rely on a future growth strategy, typically a five-year plan, as the basis for the appraisal, given this data will create a more favorable value conclusion. If you plan to value a start-up company, here are a couple of additional thoughts to consider:

• Ask your client to provide a business plan including forecasted income statements and balance sheets. It is important to advise them that the data needs to be reasonable and supportable, based on as much background and research they have performed and which they can provide details for. If the forecasts look overly aggressive, they will need to come up with as much support as possible to justify their growth plans.
• Advise your client that as a professional appraiser, you do not have forensic accounting capabilities or business planning experience, and therefore, will be relying on the data provided by them to be accurate within reason. The appraiser cannot actively participate in the development and verification of the forecasted data.
• Ensure that your appraisal report includes sufficient narrative summary discussions on the scope of work, advising readers that your value conclusions are based in large part, or even solely, on this future business plan. Add that should the plan not come to fruition, or be considerably different than the forecasted estimates, the value of the business will be materially altered.

If you, as a certified valuation professional, are not comfortable with the information provided by the client and believe it to be unrealistic based on your experience with similar situations, you should discuss this with them and ask that they adjust the data. If you can’t agree on a game plan, you can potentially opt out of the work if that is a contractual option. Valuing start-ups is a challenging endeavor therefore, ensure you have these issues covered before taking on the appraisal assignment.

Acquiring a formal certification or accreditation is critical in the valuation profession and typically requires a few years of hands-on experience and the successful completion of several educational courses to gain the initial recognized title. Once acquired, there is usually a renewal process every 3-5 years depending on the organization providing the designations, whereby a minimum of 20 annual continuing education hours are needed to maintain and extend it beyond the initial period.

Staying current on topics such as ethics, report writing requirements, industry/market developments, tax laws, and economic fluctuations is important so that appraisers can continually be aware of developments in these areas in order to provide ongoing credible valuation work.

There are a few different ways valuation professionals can accomplish these continuing education requirements. The most common is attending courses and seminars provided by their primary recognized associations, such as the American Society of Appraisers (ASA), the National Association of Certified Valuators and Analysts (NACVA), the Appraisal Institute, or the Appraisal Association of America.

Prior to the development of online course offerings, appraisers could only attend courses in person, which was more time-consuming and costly. Virtual classes are generally less expensive and allow individuals more flexibility in terms of scheduling. Some of these associations also have local chapters that meet throughout the year and create learning opportunities on a more personalized level.

Another option is to attend conferences, trade shows, and seminars provided by third-party organizations that specialize in areas such as finance, tax, accounting, economics, and specific business industries that the appraisers might focus on. Over the last few years, many of these events are now offered both in person and virtually.

The appraiser is required to track, log and report their hours to the sponsor organizations who will formally provide the recertification or reaccreditation once completed. These steps are crucial to the long-term credibility and continuing validation of both the individual appraisers and the valuation industry as a whole.

When you are seeking the services of an appraiser to value your business, ask them if they have maintained their continuing education requirements that pertain to their specific designation and their affiliated organization.

Most everyone is familiar with the commonly cited statistic that 50% of all marriages end in divorce. Unfortunately, this estimate is essentially factual, with around 40% of first marriages and 60-70% of second and third marriages making up that average figure. Experts will also tell you that the last three years of hardships (we all know which ones I am referring to) have driven these numbers up further and will continue to rise in 2023.

If one or both of the partners in a divorce owns all or part of a business, the value of the enterprise and its underlying assets will likely become subject to the overall divorce settlement. A dispute as to the assessment of the fair market value of the business is commonly a factor in many divorce cases. The best way to resolve any dispute, ideally in an amicable fashion, is to engage with a certified business appraiser, who can provide an independent value based on reviewing the company history, analyzing financial data, researching the market, and understanding the assets associated with the operation.

Divorce attorneys will often be the representatives who suggest this approach during the proceedings and will work directly with the appraiser to facilitate the collection of data from either or both parties involved. This process can get bogged down for any number of reasons, and the judge or arbitration representatives involved should look to expedite the process with the legal means available to compel the availability of the information needed for the appraiser to complete the appraisal.

Without cooperation on both sides to work through the valuation issues together, the roadblocks to settling these cases can pile up, andthe divorce terms may ultimately be decided by the courts, who have no personal stake in the business or the overall case. The courts will look to rely on any experts involved in assessing value and if both parties engage separate appraisers, it could lead to deposition or trial testimony to ultimately determine value.

It's logical to assume it would be ideal for both parties if these decisions were made amicably and mutually however, the reality is that many divorce settlements become very difficult to settle due to significant differences of opinion, making the ability to work through the process unattainable without the assistance of independent third parties. When it comes to maximizing your chances of arriving at a fair settlement of business value involved in a divorce, seek out an unbiased experienced appraiser to work through the issues with you.

 

Consultants are oftentimes viewed as a necessary evil to accomplishing the larger goal of ensuring one has all the information needed to make the wisest decisions in a business or personal transaction. Without them, you may be led down the wrong path by a biased source or someone without the knowledge and experience to provide you with the leverage needed to make informed choices.

Typically, consultants are engaged in transactions where both independence and expertise are critical to a successful outcome, whether that be in a financial endeavor, business combination, professional dispute, arbitration, or litigation proceeding. Accountants, appraisers, insurance advisors, statisticians, and legal experts, to name a few, are engaged by one or both parties in a situation where there is a significant need to comply with regulations, and settle cases where disagreement on key issues is apparent.

The answer to the question in this article's title lies predominantly with the individuals you choose to work with.

Ask yourself the following when considering engaging with consultants:

• Does the consultant fully understand the larger picture in play, and can they keep this perspective while focusing on their specific role?
• Can they remain fully independent in the case at hand, regardless of who hires them?
• Does their experience and expertise fit with the specifics of the transaction or dispute?
• Are they accredited and/or certified as a professional in their practice?

The most effective consultants understand their role in each unique situation and can work seamlessly with the parties involved, without trying to influence areas in which they are not requested to participate.

Credentials on paper can speak to much of this, however, a more personal vetting process should complement the review process, to ensure you are bringing the right consultants to the table. Don’t necessarily prioritize cost over quality, as it may come back to haunt you down the road.

In the end, a strong team assembled to accomplish the specific goals of any transaction or business dispute settlement will likely avoid a lot of unplanned costs and damages in the long run, and lead to an equitable outcome.

In the aftermath of the pandemic and in consideration of continuing economic hardships for many businesses in highly affected industries, such as restaurants and entertainment venues, the reality is that a lot of companies did not survive. These unprecedented times saw a large increase of small business owners struggling to stay afloat in hopes of a turnaround that ultimately took too long to come about.

Despite short-term relief funding programs made available by federal and state governments, there has been a significant increase in small business closures beginning in mid-2020 and continuing to this day. One of the many obligations business owners are required to undertake when closing their company involves a formal discharge and dissolution filing with the IRS.

There are several filing forms involved and depending on the existing documentation, owners may need to engage with a certified business appraiser to independently declare a final value for tax purposes. Even though it is evident that little to no revenue is being generated from business operations, there likely remain certain assets and liabilities which need to be declared as part of these final steps.

As painful as it may be, a business appraiser will need to be engaged and review these documents as part of their work effort to establish a fair net value for the remaining tangible and intangible property. Essentially, the focus is on what remains of the business that can be resold as part of the closure.

In many cases, this would be tangible property only, such as real estate, buildings, machinery & equipment, and personal property. If these assets have recently been appraised or are reasonably depreciated and accounted for on the company books, the business appraiser can use this data to document under an Asset Approach to value. This approach will likely be the only one utilized given the lack of income and external market comps considered under more normal business valuation circumstances.

Other factors will be taken into consideration that pertain to the closure status which will hopefully soften the final blows that come with this process. Making the decision to close your small business for lack of profitability, or for any other reason, can be a heartbreaking experience, and as business appraisers, we will do all we can to facilitate this process for small business owners during these trying times.

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.

When you're running a business, it can seem really difficult to determine how to build growth into your company. One of the easiest ways to do this is by valuing an industrial company to determine where it's strong and weak, what insights you can pick up and similar aspects. A often ignored option, business valuations help you figure out where to improve, where to invest and which areas you're doing great in. Here's more information on the benefits of business appraisals when you need to get your company operating efficiently again.

Valuing an Industrial Company to Create Growth

May people are under the misconception that business appraisals are only for when you're buying or selling a business. They're often surprised at the depth of information provided in a business valuation report. Do you have multiple locations in similar areas that behave completely differently? Are you trying to figure out how to improve production or profitability? Are you wondering what your business is really worth, whether you're considering selling or not? These are all excellent reasons to have a business appraisal performed.

Many business owners rely too much on their tax accounting records. But tax accounting reflects standardized tables, figures and values. The only way to know whether your business is average or not is by having a business appraisal performed.

A business appraiser who has experience in the industry may be able to offer insights into not only why the business is underperforming, but may be able to tell you how to improve operations. They can make suggestions about how to draw a different crowd to that location to make up the difference.

Some business owners make the mistake of basing their business value on what similar businesses have sold for. While this is in fact one way to value a company, business owners often don't understand how the multiples work and apply them to the wrong numbers leading to an inaccurate assessment. They can be very far off using rules of thumbs or multiples heard at the country club. Differences in income or overhead can also make a big difference. 

Speaking of income and overhead, a good business valuation specialist can tell you where your company excels, where it measures up and where it needs improvement. Maybe instead of taking a risk with that expansion, you really need to upgrade to more efficient equipment. It could be that your company provides phenomenal features in your products, but the market perception is that they don't last long. Any of these reasons can affect your bottom line.

By keeping these benefits in mind, you'll be able to very quickly use the valuation of a company to determine a smart course of action. If you need help valuing an industrial company, a certified business valuation specialist is the best way to go, as they use standardized methodologies in their reports.

When you are looking at having the valuation of a company determined, business valuation services are one of the most common places to investigate having the business appraisals done. But how can you tell whether the business valuation services you're investigating are able to do the company valuation effectively , efficiently and accurately? Here are some tips on what to look for in quality business valuations companies:

What to look for in quality business valuation services

• Certifications: Do the business appraisers have certifications from the American Society of Appraisers, American Institute of Certified Public Accountants, National Association of Business Certified Valuation Analysts or Institute of Business Appraisers? These accreditation organizations have been set up to ensure that business appraisals are being performed in a uniform fashion using the methodology that best applies to that situation.
• Business History: How long has the company been in business? You don't want to trust your company valuation process and your company's private records to a company that may not know what they're doing or may expose your company's data to any number of outside interests. A company that has a proven track record can get the job done right without a lot of changes needing to be made. One exception is a newer company that has proven professionals with significant experience behind them, but even then, you should be aware of the potential risk.
• References: Any service providing the valuation of a company should be able to provide you with references from satisfied clients. If the company is unable or unwilling to provide these references, it's probably because they have poor customer service or have unhappy clients.
• An Appeal Process: What happens if you feel the company valuation provided is inaccurate or didn't use the correct information when calculating the valuation of a company? Because company appraisal can be a somewhat fluid process, most company appraisal services offer an appeal process to ensure that the business appraisal provided is an accurate representation of your company.
• Knowledge of Several Approaches: Business appraisal is not a one-size-fits-all process. Depending on your specific needs, there may be a need for one of several different potential options when valuing your business. A quality business appraiser knows not only the several different approaches available, but will also know exactly which one provides the best possible fit for your company and exact situation.
• Availability and Approachability: Though part of the process of hiring a professional business appraiser means trusting them to get the job done, that doesn't mean you shouldn't be able to speak with them on areas of concern. Is the company appraiser available for consultation? Just as important, do they seem approachable if there is a problem? An appraiser who isn't willing to help explain their approach will leave you confused and wondering how accurate the final report will be.

Now that you know what to look for, it's time for action.