Business Valuation Blog | Understanding Buying / Selling a Company

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.

If you are a business owner who manages multiple product or service lines, you may be structured as a consolidated company with multiple divisions. These affiliated or subsidiary operations roll up into the primary business for accounting purposes, which facilitates the requirements you have for tax and other reporting purposes.

When it comes time to consider appraising any or all of these businesses, you will want to discuss the level of detail and depth you need to take to accomplish the task, while keeping in mind the time and cost associated with the valuation effort.

Let’s look at two scenarios for your business, which in this example consists of three divisions, a primary LLC company, and two dba operations. You file consolidated taxes and prepare one balance sheet and income statement as an S Corp under the LLC while keeping unaudited separate books for each of the three operations.

In the first scenario, you are considering selling off one of the two affiliates and need an appraisal of that component of your business only. If you don’t have detailed financial statements separating each entity, then you will need to advise your appraiser and they can determine the available options. One might be to value the main LLC company while taking the results and breaking them down internally and applying a percentage of the total to estimate the value of the subsidiary. This may not be 100% reliable given the potential inaccuracy of your assumptions when making these adjustments. A better option may be to create a separate income statement and balance sheet for the subsidiary that the appraiser can reasonably rely on and have them value both the LLC and the affiliate or just the affiliate, depending on your needs.

Under the second scenario, you are looking for new investment either through equity infusion or debt financing and the investor or bank needs to review the financial strength of the entire operation. In this instance you can likely just have the appraiser value the consolidated business, relying on the reported financials while holding general discussions with the third parties as to the breakdown of the overall company.

Regardless of the potential situation you find yourself in, it is always a good idea to keep separate books for each division either formally with the support of your accountant, or through your own internal organized bookkeeping process. This will enable you to have the financial data available when needed for the appraiser who can best understand the overall business and allow them to break down the value of your subsidiaries in a reliable and supportable way.

As a business owner, no one knows more about your company, its operational history, and where it’s headed going forward. When you determine the need for an independent appraisal, the ability to work in tandem with the company you choose to engage with will benefit all parties involved.

There are very likely areas within your financial statements you can elaborate on to paint a more accurate picture than simply what the numbers show. In addition, your experience with the markets and industry you operate in will provide added perspective to the appraiser when they research the competition and comparable businesses during the course of the analysis.

Review overhead and expenses to determine if any are discretionary and adjustable to how you might otherwise operate on a leaner budget. Look at what might be considered “one-off” costs in certain years that can be backed out of annual cash flow levels and review special compensation packages to you and your employees which might not be relevant to a potential buyer. You may be claiming a lower net income figure on your taxes each year because of these discretionary expenses. That is a common strategy for business owners each year as they best position themselves before year-end filing.

The goal is to create a normalized, realistic year-to-year snapshot that shows how the business can most efficiently and effectively run without consideration for added unnecessary benefits you may have created over the years for you and your staff.

When a small business changes hands, the new owner will have their own set of circumstances to consider and will often look at the most economical model to begin their operation until they too can create these added benefits once they become successful in the coming years.

From a market and industry perspective, advise the appraiser of local competition and similar businesses that may be public or available enough to make reasonable comparisons. Discuss future areas of growth you may have implemented but have yet to fully realize the added revenue streams.

It’s important to add these levels of perspective where you can so the appraiser better understands your business beyond the standard documentation that they are provided with by you or your financial advisors. The more the appraiser knows about your personal experiences as they relate to the history of your company and its operation, the more accurate the valuation results will be.

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.

As a majority owner or equal partner in your business, there may come a time when you need to settle a buyout request from another partner or investor who is opting out of their ownership interest. When this occurs, there are a few things to focus on that will impact the agreement and it is common to look for guidance and assistance, including the engagement of a certified valuation professional.

Does your company have an internally developed buy-in/buyout or another type of operating agreement that lays the groundwork for assessing value when these situations occur? Proactively handling these eventualities is never a bad idea and is quite common for rapidly growing businesses that are frequently looking for new investors to manage capital funding requirements and add value.

Is the partner or minority shareholder a key contributor to annual revenue? If so, is there a non-compete agreement in place to buffer the effects of this departure in the short term? If not, should the company be valued with the anticipated losses in sales or is there a mutually agreeable arrangement to replace the partner and offset this reduction?

If the investor is buying out of a minority interest, should discounts be applied to reflect the value of his or her shares in relation to majority ownership? This topic is commonly debated in valuation assignments where the shareholder may not have the same level of control as a larger investor, or it would be more difficult to attract a replacement given the lesser interest.

Given these variables may create a divide between the parties on the ultimate price to be paid with partner buyouts, a dispute may ensue which may drag out the process and even lead to litigation between the parties. Engaging with a certified professional business appraiser will provide an independent, unbiased assessment of value which will hopefully facilitate a fair settlement.

In any case, when a minority owner or partner opts to buy out, it may warrant the need to formally update the value of the business and associated shares so you and any remaining investors can better understand the overall current status of the company. The benefits of having an independent appraisal of your business and the underlying assets can go well beyond these immediate concerns such as assisting with future growth plans and reviewing your tax and accounting requirements.

When business appraisers value small to mid-size companies, the most common documents that are reviewed will include financial statements going back 3-5 years that track the company’s performance over its most recent history. This data should be indicative of past operational performance; however, the appraiser needs to carefully review what they see on paper with the business owner to fully understand the larger picture and potentially make adjustments in areas such as discretionary/variable expenses and officers’ compensation. This ultimately creates a true picture of the company’s assets, cash flows, and profitability.

As a business owner, this same type of practice should be undertaken internally every year or two so you can carefully review all aspects of the operation and determine where consistent trends appear while uncovering areas that may be more volatile. This way, you can make adjustments to correct deficiencies and further capitalize on the more successful sectors, to create an optimal working environment for the future.

For many business owners, a 5-10% improvement in areas such as market share, gross revenues, costs, and profitability can make a meaningful difference in overall performance. It might free up working capital to invest in sorely needed improvements to your office equipment or make the difference that enables you to hire a new employee to assist with a slow-moving operational area or to build up the sales force. You may determine this adjustment could make you appear more proactive and successful to a new investor or partner looking to come on board in the coming year.

Whatever the desired result, getting into the habit of digging deep into your company’s year-to-year performance to understand better what has been working well and what might need tweaking, is a great practice to initiate, especially for owners looking to get that extra edge over their competitors. This is one example that can create an opportunity to be the best at what you do and allow for continued growth and success.

A few times each year, I like to discuss future planning strategies and long-term growth with business owners, and how they look ahead while keeping one eye on past successes and failures. Oftentimes, forward-thinking involves the potential for expanding the company, however, what if your firm is at the point where everything is running smoothly with revenues and net income right where they should be?

There may come a point when forecasting over the next few years involves simply keeping the structure of the company the same while making minor tweaks to refine existing strategies that will potentially improve margins. Is this an example of resting on your laurels or has all the hard work in the past finally reached a point where major changes are not economically feasible? Perhaps you are even risk-averse to future growth since diminishing returns would be a likely outcome.

This type of strategy may be more common than you think. Being a successful business owner does not always equate to having the compulsion to constantly reinvent the wheel. In fact, many experienced entrepreneurs in niche markets understand that once you have reached a certain level of market share, you have essentially positioned the company at the ideal point where current revenues, overhead, and profits are at optimal levels.

Depending on your overall personality, current drive, and where you are in your career path, it may be the perfect time to enjoy the fact that the business is exactly where you planned it to be years ago and consider whether you want to take a breath while reaping the rewards or move onto another opportunity. You have options in front of you, even though they may not be the same ones that got you where you are today.

Looking inward and reviewing how best to maximize the benefits of your existing employees and client relationships while fine-tuning a business that now needs only minimal maintenance are things you can do regularly. After all the challenges you’ve faced and past successes you accomplished, that is a great way to keep your company optimized.

We all know about new year’s resolutions from a personal perspective, along with the challenges these can bring in accomplishing them both in the short and long term. One of the hardest things for many of us, in both our day-to-day lives, and as business professionals, is examining the things we don’t do very well, and changing our habits permanently, to create a more successful outcome.

As a small business owner, you may feel even more invested in making these course corrections for your company each year as you assess past achievements and look to improve areas where results were less than optimal. This behavior is part of the core foundation of a long-term growth strategy that keeps your business operating as efficiently and effectively as possible. As the larger industry and marketplace, you work in changes over time, you need to keep up and adjust for these external issues. Also, review your internal structure and processes and determine whether there is room for improvement in any areas that drive revenue and control overhead and variable expenses.

Consider who on your team has outperformed expectations and how they might help take your business to the next level by promoting them or expanding their responsibilities. Keep an eye on employees who may be going in the opposite direction and determine if you can bring them back into the right mindset or potentially need to find alternatives for their role in the company.

Even if you had a very successful year in 2022, it is prudent to refresh your outlook on how the operation functions, while continuing to improve and create further growth opportunities. The concept of “if it ain’t broke, don’t fix it” doesn’t apply in situations where change occurs, both within and outside of your control, in the business marketplace, and right at your doorstep.

Seek to obtain advice from key advisors and employees who you trust and work with on a year-to-year basis. Objective opinions outside of your own experience are always useful to potentially view things from different perspectives before you fully commit to a course of action.

Give yourself the opportunity to look back at 2023, a year from now, and tell yourself you did everything you could to continue to create the best version of your company. Every objective may or may not be accomplished, however, putting in the effort to carefully consider all the options to remain successful, and continue to grow, will be rewarding.

Each company within every industry has certain key factors that determine and drive the success of the operation. It is therefore important to take a deep dive into yours and understand exactly what those variables are so you can continue to maximize the positive impact these have on revenues, costs of goods sold and operating expenses.

What parts of your business are making the biggest difference to your bottom line?

Consider the following:

• Marketing variables such as website optimization, social media messaging, or a strong sales team.
• Unique product offerings that may create higher margins than your competitors and allow you to provide customers with better pricing.
• Client communications that are consistent and effective.
• Commitment to timely delivery of your products and services.
• A strong market reputation based on decades of experience, expertise, and proven results.

It might be a combination of these variables or something even more distinctive that creates the value added that separates your business from all others in your industry and specific market niche.

Once you, as the business owner or executive, have a good understanding of what these factors are, you can discuss them in detail with service providers and consultants such as your accountants, financial institutions, and investment advisors. You can also share them with outside consultants such as business appraisal professionals and brokers who will work with you closely to develop the documentation necessary to exhibit the level of financial value your company truly supports.

Some key variables may not be readily apparent on balance sheets and financial statements so it is vital to create a way to break down the numbers further and make adjustments that can be supported in a more detailed analysis. By carefully explaining all these factors to those who will, in turn, independently and reasonably verify them, you will afford yourself the best chance to translate them in a more tangible way that will be obvious to those who will take an interest in your business down the road.

For those tireless small business owners whose hard work and good fortune have enabled them to build a profitable, growing company, it might be time to consider how best to “share the wealth” and develop beneficial plans for your employees while accessing profits to accelerate your retirement planning. Here are a couple of thoughts to get you moving in the right direction:

401K Plan

Many of us have previously worked in a larger organization where 401K plans were available as part of a benefits package. Setting aside a percentage of your paycheck on a pre-tax basis that diverts to an investment retirement account is a sound future plan for many employees. Certain corporations will match the employee contribution up to a certain amount, typically 3-6%, providing additional advantages to the plan.

Why not set this up in your small business? This will benefit both the business owner and current employees while improving the attractiveness of your company to potential new hires.

Employee Profit-Sharing Plan

A profit-sharing plan can create a significant benefit for both the business owner and their current staff and provide additional assistance in retirement planning. These plans act like deferred annual bonuses for the employees while enabling the business owner to deduct profits on a pre-tax basis as a bottom-line expense to the business.

Similar to the 401K plan, these funds act as a longer-term investment. For employees, there is usually a vesting period that accrues every year, creating an incentive to stay with their employer until the account is fully vested. 20% annual vesting is common, creating a five-year timeline before the funds are 100% accrued.

Combined Plans

Creating a multi-level investment plan for you and your employees can create even more advantages for those who participate. For example, combining a 401K with a profit-sharing plan may allow the business owner to realize a maximum level of pre-tax income benefits allowable under the tax laws. Once you have committed to developing these kinds of ideas internally, you should contact your financial advisors who will take you through the detailed steps involved in creating and enacting these plans, while explaining how best to structure them for your specific business. This can be a complicated process so make sure you fully understand all the pros and cons involved before formalizing.