Business Valuation Blog | Understanding Buying / Selling a Company

When you're in the process of negotiating a business sale, one tool stands out above all others whether you're the buyer or the seller: the business valuation. But why is it so important to the process and how does it protect both parties as the negotiations go forward? Here's a quick overview of what a business valuation is and what it can bring to the negotiating table.

Why is business valuation vital to negotiating a business sale?

Selling a business can seem like a fairly straightforward process. A buyer and seller connect, agree on a price and transfer ownership, right? However, it's not nearly that simple. How is that price determined? Did the seller simply look at recent sales of similar businesses in the area and use those prices? How do you know whether the asking price is fair or not? Is the buyer or seller being taken advantage of? These questions can plague those who are tied up in business sale negotiations.

Fortunately, there's an easy solution that keeps both sides happy during the negotiation process. A business valuation uses an independent third party who has had training in tested methodologies to calculate the business' overall worth. Because the appraiser is an independent party, they have no interest tied up in inflating or deflating the company's calculated value. This means that the value they calculate is much more likely to be favorably received by both parties in the negotiation process.

The appraiser is also able to use some amount of flexibility in the valuation, depending on the exact circumstances. They can create a valuation report focused on a quick sale, which may not net as much as the seller would like overall, but is often helpful when an estate needs to be settled and the heirs to the estate want a fast resolution to the process. If the seller is willing to wait for the right buyer, a higher value may be calculated to reflect that ideal circumstance.

But what about the buyer? With the independent approach of a certified business valuation specialist, the buyer knows they can have confidence that the calculated value is accurate. Because of the level of research used in the appraisal, the buyer can rest assured that there has been a solid investigation into the company's finances, the condition of the market, the industry's outlook and any special features of that business that can increase or decrease its value. 

For example, when a company has a reputation for innovative product development, the owner may inflate the asking price. But what if the owner's role in innovation is a vital part of that process? The new owner may not find as much value in the company when one of the major innovators is leaving with the sale. A business appraisal looks at these aspects and how the company will change with the sale. They can then take that into account and determine how much of an impact that will have on the overall value.

By getting a business valuation as a part of the process of negotiating a business sale, both sides realize significant benefits in the process. They can walk away from the negotiating table knowing that they've done a good job. The valuation process, when completed by a certified business appraiser, helps ensure that everyone is getting a fair deal. 

When you're looking at a business' overall financial standing, one term that is often tossed around during a business appraisal is valuation multiples. Multiples of what? How is the number calculated? What does it mean to your company's value on the market? Though it can seem like a complex concept, it actually breaks down fairly simply. Here's a quick overview of what valuation multiples are, how they're calculated and how they can impact a company's overall value.

How are valuation multiples calculated and how do they impact your bottom line?

What are they?

Much like multiplication, a valuation multiple represents a specific business value multiplied by a particular figure. That value is typically related to income in the form of discretionary earnings, gross revenue or market conditions. The figure by which it is multiplied is the valuation multiple. Depending on the company involved, this multiple can be anywhere from a small single digit to pushing three digits. 

How are they calculated?

Multiples represent a certain expected amount of income per year. If a company has a multiple of 3x, it means that a buyer is willing to pay the equivalent of three times the expected income to the seller. This means the company's income will pay back the investor over the course of three years, if it continues to perform as expected. A multiple of 5x means the company is valued at five times the projected annual income and that a buyer will see the investment returned over a five year period. However, if a company is actively growing, much higher multiples may be seen.

How do they affect your company's financial situation?

But what impact can these multiples have on your company's financial situation? A startup tech company may only have revenue of $50,000 the first year of operation and $200,000 the second year. If it's purchased at this point, where should the multiple fall? If it's expected to grow to a $20 million annual concern within five years, even paying a 10x multiple on the current $200,000 annual income would only equal a value of $2 million. In this case, a 50x multiple may be considered acceptable.

This not only applies to buying and selling a company, but also to the process of securing financing. Will the tech company, as it stands, be able to reach that level of growth? If it needs additional capital to be able to pull off the expansions that are needed, the company needs to be able to prove to the bank that the company will be able to pay back those funds in good time. An appraisal from a certified valuation specialist uses standardized methodologies to document the company's ability to repay the loan that stand up to strong scrutiny in financial circles, making it easier to secure the financing.

By having a good idea of how valuation multiples are calculated, you're in a better position to improve those numbers and pay or receive a fair price for your company, whether it's for a business loan, a company sale or a business purchase. Knowing where your business stands allows you to improve areas that are weak and push areas that are strong even further to help ensure a successful venture. By working with a certified business appraisal specialist, you're ensuring that the multiples and figures you work from are accurate and represent a solid calculation of your company's overall value.

When you're trying to figure out your company's finances, there are a wide range of formulas and techniques that are available. But which one will work for your company and how will the different options impact your bottom line? One option is looking at earnings before interest, taxes, depreciation and amortization (EBITDA). But exactly what is EBITDA? Here's a look at how this type of value is calculated, what it means to your company and how it can affect your bottom line.

What is EBITDA? How does it impact your company's finances?

So exactly how is EBITDA broken down? Let's take a look:

• Earnings: This refers to net profit, or the amount of money your company is bringing in minus expenses and overhead.
• Before: This one's as simple as it sounds - it's the earnings before everything else is taken away.
• Interest: Interest is typically the figure listed on your company's income statement. It represents the cost of interest on loans and similar financial instruments for that period.
• Taxes: Taxes are also taken from a company's income statement, making it easy to work them into the figure. This refers specifically to income taxes only.
• Depreciation: Depreciation refers to how much value an asset has lost over a particular time period. It may be determined using a depreciation table or schedule, or using an equipment valuation to determine change in value.
• Amortization: Amortization is the expense of a loan, typically in terms of the amount of the loan that has been paid over the year, representing a gain in an asset's value to the company and a lowering of debt.

In general, EBITDA is a great way to determine a company's profitability, but not necessarily its cash flow. This is because it does not actually represent cash earnings, but looks at a wide range of other factors that may come into play with a company's finances. Because it is not a generally accepted accounting principle measure, there is greater leniency with regards to what exactly is included in the statement. It was originally developed to determine a business' ability to service debt. As time rolled on, it became more common when industries had expensive assets that were used for long periods of time. Since that time, it's become a commonplace calculation in virtually every available industry, including the tech industry.

Another report that provides the same basic information is the earnings before income and taxes, or EBIT. The only difference between these two is whether the depreciation and amortization are included in the calculation. When they are excluded from the report, it doesn't mean that they're not being counted, because earnings in this situation refers instead to the company's operating profit.

What is EBITDA? Now that you have a better idea about how this income can be calculated, it's much easier to gain an understanding of how your company operates and its overall financial health. Another aspect of that understanding is the insights you can gain from a business valuation. Business valuations not only provide you with the value of your company, they also deliver information on the market, the industry, your competition and where your company is strong and where it is weak. Why not look at having one performed to see where your company can go from here?

We've all seen examples of it. A business which, though nothing special at first glance, has amazing customer loyalty in the community and a larger market share than makes sense in the area. How exactly does the business gain this type of reputation and loyalty? Even more important, how is that part of the business valued in an appraisal? Goodwill can often have a great deal of benefit and monetary value but is a complex topic. Here's a quick look at how the process works.

How is goodwill calculated in a business valuation?

Unlike your company's material assets, which is considered a tangible asset, goodwill is an intangible asset. It can not be calculated outside of a full business valuation. But exactly how is it calculated? The most basic calculation takes the fair market value of a company's assets and liabilities, and then deducts the amount from the sale price of the business. The remaining amount represents the company's goodwill.

However, it's not as simple as adding up columns in a ledger. How do you calculate fair market value for your company's assets and liabilities? How can you be sure that the figure you have calculated is actually accurate? Will it stand up to strong scrutiny if your business ends up dealing with insurance, legal or financial woes?

But where does goodwill come from and how can you determine whether your company has acquired it? It can come from a wide range of aspects of your company. Are you top in your industry and well known for developing innovative new techniques, products or services? Perhaps your industry is entering a boom and the anticipated future income is increasing its value beyond what it would normally sell for. This is yet another example of goodwill.

What about strong community ties? A company that has spent many years or even decades in the community, building a name and a strong customer following, may have additional value for those reasons. Even better, it's quite often value that a new owner may be able to leverage to their advantage. This is especially true when the previous owner helps pave the way with the community or industry.

Calculating all these potential sources can be difficult, especially if you're considering selling or buying a business. Justifying the amount to be paid for goodwill is equally difficult. What is fair market value for your company's assets? When you have a company that has generated significant goodwill in your industry or region, it can be hard to determine the value of that reputation. Fortunately, you don't have to. A certified business appraiser has the training and experience to create a valuation report that reflects the value of all your company's assets, tangible and intangible.

When a certified business valuation specialist prepares a valuation report, that individual has the knowledge of how to best determine the company's overall value and then calculate the goodwill by separating out the fair market value of the assets and liabilities. But in addition to simple cash value, they will also consider the market conditions, the industry as a whole and any other aspects that may impact the company's value.

Once this process is complete, they'll present the results in a report for your consideration. Once all parties agree that everything has been included in the process, the final value and the value of the goodwill is settled. From that point, it's up to you to decide what to do and with a certified appraiser's report, you'll be able to negotiate from a position of strength.

Though there is no specific date where we can look at say, "This is the start of business valuation," knowing the history surrounding the development of business appraisals and how this specialized branch grew out of accountancy and appraisal services is helpful to understanding how today's changing market conditions can affect the valuation of a company today. Business valuations can be a complicated topic, but valuation companies have grown out of the demand for better accountability and finer margins in business to maximize productivity. Here are a few short paragraphs on where valuation companies have come from, how they have developed into the complex but extremely accurate reporting systems we see today and where they may take us in the future.

A brief history of valuation companies

Though there is some debate as to the exact time period when the first valuation company or service emerged, it was undoubtedly in the middle of the 1800s as the Industrial Age saw the growth of immigration and larger companies began forming as technology advanced in communications, transportation and climate control, and made it easier for workers to perform more uniform tasks. As these companies were sold, accountants and actuaries were first called upon to study the financial documents of the day to determine their accuracy and the value of their projections. Starting on the east coast of the United States, the Massachusetts legislature passed a law in 1858 that required a commissioner to calculate the potential reserves of policies for all companies in the state that required licensing, to ensure that they were properly covered if needed. 

The original methodology used was the Net Level Premium Reserve Method and the combined experience of the companies, based on the 1843 British Mortality Tables and an average interest rate of 4%. Since that time, the basic methodology has not changed, only which inputs, risk factors and range of information is used to calculate the final company valuation based on their exact circumstances. Later, as the formation of the IRS required better tax accountancy and the 1920's brought about prohibition, the tax breaks and compensation paid to the major breweries and similar businesses by the U.S. Government created the right circumstances for another viewpoint to form. This revolutionary concept was that a company was actually worth far more than simply its assets minus its liabilities or only its equity, the main calculations that were used to that point. This development brought about new concepts including the value of future profit and goodwill in calculating company valuation. 

Up until the 1990s, the work of calculating business value was strongly done by accountants and actuaries, but the development of the internet and the Information Age further narrowed this specialty until business appraisers were able to strike out under their own banner. The National Association of Certified Valuators and Analysts was begun in 1990 and has organized these previously diverse valuation specialists under one united banner, which continues to this day.

As our world and markets continue to diversity, we can expect to see further specialization of business appraisal firms as time goes by. Because business valuations allow you to see exactly where your assets and liabilities are, they are vital to the continued growth of your company and will become a necessary partner for successful companies worldwide as time progresses.

When you're entering the world of business valuations, there is so much to learn! Whether you're stuck with terminology, need a better grasp of the different methodologies used and why they apply to each situation or just want a better idea of how the valuation of a company is undertaken, these fabulous business valuation resources will help you quickly understand the complexities of business appraisals so you can use these tools to the best advantage of your company:

4 Business Valuation Resources to Help You Understand the Process

1. Business Valuation Resources (http://www.businessvaluationresources.com/) provides a little of something for everyone. Whether you're a seasoned business veteran who is looking for the latest industry intelligence to determine how it will affect your business' appraised value or are just starting to learn how business valuations can help get your business off the ground and make it more successful, this website has a wide range of topics dealing with business valuation.
2. Valuation Resources (http://www.valuationresources.com/) is an excellent site to investigate if you want to find out more about how the valuation of a company in your specific industry is typically undertaken or how it has been affected by recent changes in the market or methodology used to calculate business appraisals. It also has some great resources for exploring different methodologies used in business valuation, including transaction date on similar businesses and the often misunderstood concept of multiples.
3. AICPA's Business Valuation (http://www.aicpa.org/) gives you a good glimpse at the kind of information certified business valuation specialists work through on a daily basis. As one of several accreditation organizations, the AICPA provides information on their site that both veteran and newer business appraisers work with on a daily basis, giving you some insight into how the process works and why particular approaches are taken to your business valuation appraisal.
4. Business Valuation Law (http://www.businessvaluationlaw.com/) covers the legal side of business valuation. For certain situations, there's actually law in existence about what type of approach must be used, such as in a divorce or hostile partner buyout. This site covers some of the latest changes in business valuation law and how new laws may intersect with business valuation in expected or unexpected ways.

Now that you've had an opportunity to gain a better grasp of company valuation through these business valuation resources, it's time to start applying this knowledge to your company's benefit.

When you are considering a "divorce" from a partner, it can be very messy trying to figure out an equitable solution to dealing with your business, especially in community property states. Both sides want to benefit from the deal, and it can be hard to find a solution that everyone can live with, especially when one or both of the spouses want to continue working in the business and the parties are not willing to work amicably towards an agreement. But a divorce business valuation can provide a quality valuation of a company that uses standard practices by a qualified, impartial appraiser to determine a fair value and a fair deal for all concerned. Here's how getting a company valuation works in a divorce works and the specifics of which valuation methods are used in this situation.

Using a Business Valuation to Get a Fair Deal in a Partnership Divorce

• It's important that you get your valuation of a company through a qualified, certified business valuation appraiser. Because a professional appraiser has gone through the training and nows the appropriate standards to use in your situation, doing so will help you avoid spending money on an appraisal from an untrained person that may not hold up.

• One method often used in business valuation is the market approach when looking at comparable businesses. By taking into account different business attributes and investment risks, it's possible to develop a comprehensive valuation that is fair and equitable to all sides in the business.

• Though it's common in non-adversarial situations to use a comparable transaction method under the market approach, the most common data source only go back a single year, but doesn't address prior years. Because a seller in non-adversarial situations is often actively trying to paint a good picture of the business income to get the most out of the sale, this approach doesn't work well in a partnership divorce business valuation.

• When a qualified business valuation appraiser is used, it's easier to find an equitable solution to the problem. This is especially important in situations where there are allegations that one party has not been running the business honestly. Because a qualified valuation specialist can study the figures that play into the business' final valuation, it's easier to locate potential problems or mis-reported figures.

Though partnership divorces are, by nature, painful and emotional, coming to a fair and equitable valuation for your business doesn't have to be.

Smart businessmen and women understand that it is important to consider selling a business before the day arrives. Yet all too often, medical professionals -- from wellness providers and holistic health care providers to medical and dental practitioners -- do not have an understanding of key business concepts that can help sell their practice. Learn how to value a company and why you need to do this before you put a medical practice on the market. 

How to Value a Company in a Medical Field

There are many different company valuation methods that a business appraiser might use to value a company. Commonly used methods include the asset, income, and market approach. 

Asset-based company valuations focus on the value of business equipment and assets. If you have a lot of modern specialized equipment, such as x-ray and diagnostic imaging machines, then an asset-based approach may benefit you. 

An income-based approach may examine your cash flow or take capitalization of earnings. The latter method works well for established, stable businesses such as an orthodontist office that has a demonstrated pattern of regular patient growth over time. 

A market approach might compare the medical business to those similar to it, or use multiples of growth revenue. This approach works best when there are similar businesses in the community to compare your medical business to, and does not work as well in rural areas. 

While you do not need to know the fine details of these different methods, it is helpful to understand the basics so you can review your appraisal report. After the appraisal, you may decide to make strategic business investment to grow the value of your company before a sale, especially if the sale you anticipate is far off. 

A business appraiser can discuss your needs, your business history, your growth, and your reasons for selling the business. Based on the information gathered, the appraiser can then select the right approach or combination of approaches to obtain a fair market value for your business. 

Why You Need a Business Appraisal for a Healthcare Practice

If you try to sell your healthcare practice without getting an appraisal first, you risk setting yourself up for a frustrating experience because you do not understand the true fair market value of your company. You might be sentimental about your company and set a price too high to receive an offer. Alternately, you may undervalue your business due to personal fears and end up selling the company for less than you deserve. 

Knowing the valuation of a company, you can understand its unique selling points and better market your medical practice to new dentists, doctors, or health and wellness experts. You can decide if you want to sell the business as-is, sell equipment separate from the business, or sell your practice separate from real estate. You might retain building ownership and transition into being a landlord renting office space. 

If you are considering selling your practice to a hospital, as is common at the present, you may want a business appraisal as a form of leverage. When you know your practice's value, you are in a better position during negotiations. 

At Business Valuation Specialists, we perform business appraisals for a wide range of companies, including medical practices. Let us take the lead in your business valuation, so you can sell your medical business for a fair price. 

When you run a manufacturing company, there are many areas where you can make improvements or tap into additional value. Some of these involve taking risks in entering new markets, doing extensive mapping of your strategy or planning your actions in the market when you're not sure what the future may hold. But one of the most under utilized tools used for finding hidden value in your business is the business appraisal. Business appraisals look at a wide range of factors to determine a business' true value. It also makes it easier to find where your business has potential for significant growth. Here's how having a business appraisal performed helps you find that hidden value.

How valuing a manufacturing company reveals hidden value

The first area you'll find value is where your business is not performing up to standards. How is that adding value? Because it helps you ensure your company is as strong as possible. This allows you to improve your business, building its value. Are your assets overvalued because they receive more wear and tear than your competitors? Is your overhead too high because you haven't replaced the old, power-hungry light fixtures in your plant? Is there disruption happening in your industry that may lead to a downturn for more traditionally-modeled businesses? By knowing where your business is weak, you know where to improve it to ensure it will do better in the future.

But how do you compare to your competition? Because business valuation specialists spend their days working with a number of businesses in your industry or related industries. This gives them the insight to what a healthy manufacturing business looks like. They can compare your business to others that are similar or to similar businesses in other industries that are going through the same type of conditions and issues your business is facing. Is it a good time to diversify your production line? Should you look at digitizing your operation to reduce overhead? Having a business appraisal means you can learn from other business' mistakes and successes.

When you're considering expanding your business by merging with another company, do you know the condition that company is already in compared to your own? A company valuation of that business provides the same level of insight. If that company is strong where yours is weak and vice versa, they may be able to compensate across the board and make the merger a success. If, on the other hand, you're looking at a business that has similar weak points, you could simply be taking on unnecessary risk that could cost you your existing manufacturing company. By having a business appraiser take a solid look at both companies, you know what you're getting into from the start or can avoid making a bad investment all together. 

As you can see, there are many areas where your manufacturing company has real value that may be hidden. By taking advantage of the information provided in business valuations, you can improve your business' position in the market and take smart opportunities. If you need help getting the valuation of a company, it's important that you work with a business appraiser who has the necessary training and experience to give you the information you need.

When you work in manufacturing, you often work with numbers on a daily basis. Specifications, supply costs, overhead: these numbers are very important to the daily operation of your company. But what about valuing a manufacturing company? There are many benefits to having business appraisals performed on your business for a wide range of reasons. One area where manufacturing companies see real results from business valuations is in reducing overhead and production costs through a solid look at where your company is strong and where it is weak. Here are some ways  business appraisal helps:

Maximizing Production: Valuing a Manufacturing Company

Improving Production and Operations

One of the first areas where you'll find room for improvement in your business is through a solid study of business operations. An experienced business appraiser can provide insights into where your company meets the average, where it excels and where it is lacking. Because a business appraiser looks at specific parts of your business, they can quickly determine, for example, if your company is losing money in excess manufacturing waste, inefficient machinery that uses too much electricity or material and whether you're paying too much in property taxes due to a poor assessment by your local tax assessors office.

Improvement in Management and Accounting

Another area where there's room for improvement is in management. If your company is relying on tax accounting records to estimate value, assets and equity, you may be selling yourself short. Tax accounting often depreciates value for a piece of equipment over a specific period of time. If your equipment is failing before that point, you're not getting the full depreciation out of it and you may be overestimating your assets, because the machine is not worth its depreciated value. On the other side of the coin, machinery that is lasting significantly longer than the depreciation period may still have value when the books report a zero value. That means you aren't able to take advantages that come your way, because you don't think your assets are high enough to cover the potential risk. In either case, a business appraisal allows you to determine when to replace vital equipment, providing better budgeting intelligence.

Projecting Income and Market Growth

But what about income? When you're getting ready to expand your manufacturing operation, being able to project your expected income is important both in assessing the risk and in obtaining financing. A certified business appraiser can quickly determine your projected business income based on past income. Though this is easier to calculate when a business has regular income, it can also be estimated for irregular income. A business appraiser also has the knowledge to look at current market conditions and account for those potential disruptions in their calculations. This means when your industry is expected to do well for a period of time, the appraiser takes that into account.

As you can see, valuing a manufacturing company can provide great benefits and insights into how your business works and where it needs improvement. It also provides proof of value for any number of other purposes, from financing to insurance to sale value. If you need to get the valuation of a company, please feel free to contact us today to be paired with an experienced certified company valuation specialist. At Business Valuation Specialists, our job is making sure your business appraisal is completely accurate to your unique situation.