As a business owner, one of the most important questions you need to answer is: What is my business worth? However, that question is not necessarily one you can answer by yourself. Therefore, when contemplating your exit options, you should consider receiving the advice of a professional.
At this point, you may find yourself asking a number of questions, such as: What is a valuation? How much does a business valuation cost? Should I have an appraiser, a broker, or my CPA value my business? Do I really need a valuation for my business? What is the process of determining the value of my business? This article addresses these questions and others, and guides you through the critical decisions you need to make when planning to sell your business.
A business valuation is the process used to determine how much a business is worth. The end result can range from a verbal opinion of value, to a short written report that estimates the value of your business, to highly complex formal reports that exceed 200 pages long. These types of appraisals range in price, as they can cost anywhere from nothing to tens of thousands of dollars.
Business valuations are used for many purposes. The value of a business is often needed in divorce proceedings, tax planning, bankruptcy proceedings, litigation, buy-sell agreements, and strategic planning. It is also needed when arranging financing and assessing economic damages for litigation. Most appraisals are performed for legal purposes and receiving an appraisal in this format is of limited use to you if your intent is learning the value of your business to sell it. That is because the appraisal may not reflect the actual market value of your business.
Unfortunately, most business appraisals are written for those involved in litigation, or other legal matters. Therefore, most use complex language that is difficult to understand, and include formulas that are of little use to a business owner.
For example, most appraisals contain an in-depth analysis of national and local economic factors that affect the value of a business, which is required for appraisals intended for legal proceedings. However, most owners are familiar with the economic factors that affect the value of their business, and do not want to pay an expert to prepare a report to discuss these factors. Appraisals must follow guidelines and standards, and most of these standards require the appraiser to analyze these factors when preparing the report. These guidelines are in place so that appraisals comply with the specific requirments of different types of legal proceedings. For example, an appraisal for a divorce may require a strict definition of value, such as “Fair Market Value,” while an appraisal for another purpose may require the standard of “Fair Value.” Such differences may seem minute, yet appraisals for legal purposes must follow a number of exacting standards.
As the business valuation industry has progressed, these standards have become more complicated, and as a result, the standard business valuation report has lengthened over the years. Following these standards results in an increased amount of time to prepare a report, and an increased price. As a result, most business valuations are of little use to an owner becasue they are too esoteric and confusing, and therefore, are of little practical value.
Many business brokers and M&A intermediaries are confused by these standards, and therefore, they decide not to offer business valuations as a service. Subsequently, most of the people offering business valuations are business appraisers and CPAs, many of whom have never sold a business in their life. They have no understanding of the process of buying and selling a business, nor do they understand the marketplace, which raises the question: Would you pay an appraiser thousands of dollars to determine the value of your business if that person had never sold a business personally?
As a result of these complicated legal standards, most business valuation report software is designed specifically to produce valuations for legal purposes. Nearly all appraisers use commerical software when preparing a valuation, while some have produced their own software. You will have difficulty finding an appraiser that uses valuation software designed with the purpose of selling a business in mind. Unfortunately, the report produced by most valuation software is highly technical and not of much use to you as a business owner. We recommend asking to see a sample report from an appraiser. Read it, and see if you can understand it. If you cannot, then it may not be worth your money to buy it.
Most business appraisals use fair market value (FMV) as the standard of value. Fair market value is the price at which a business would sell between a willing buyer and a willing seller, without taking into account the strategic value to the buyer.
Strategic value, also called investment value, is the value of a business to a specific buyer. It can represent the added value to a potential buyer of a business who is in the market for a specific type of business, or who is interested in being the owner of a particular brand or patent. For instance, a buyer who already owns a business in one area of the market may want to buy a similar business to have fewer competitors. Therefore, similar businesses to the buyer’s will have a higher strategic value to that buyer. You cannot measure strategic value until you know who the buyer is.
Most businesses priced at less than $3 million will sell based on fair market value whereas many businesses priced over $3 million will not sell based solely on fair market value, and therefore, their selling price represents the businesses’ strategic value. It makes sense to perform an appraisal of your company if your cash flow (EBITDA) is less than $1 million annually. For companies with EBITDA in excess of $1 million per year, a valuation will only serve to establish a floor (minimum price) at which the company will sell. Many lower middle-market companies sell in excess of their fair market value if they are sold to a strategic buyer.
When considering whether you should have your business appraised, you have many options. The various types of business valuations do not have standard defintions, so it can be confusing. You have a large number of options, and below, we’ve given you a description of those options. Most reports fall into three main categories: a verbal opinion, a written report for non-legal purposes (such as a business sale), and a written report for legal purposes.
Business Broker– Many business brokers offer to prepare a business valuation for prospective clients. Most brokers offer a free report as a lure to induce prospective clients. Unfortunately, you won’t know what you are getting because business valuations are not required to follow particular standards. More experienced brokers charge a fee for a valuation. However, if the broker is working on commission, then a conflict of interest exists because the broker is initially tempted to provide you with a high opinion of value so they can attain you as a client. The problem is, few business brokers have more than a rudimentary understanding of business valuation.
Third Party Report – Several appraisers offer their appraisals through a network of business brokers. These networks actively market their services to business brokers, charging as little as a few hundred dollars, while the brokers may charge what they please. One major franchised business broker network actively convinces all of its franchisees to market their 3rd party appraisal services.
CPA – Accountants and CPAs sometimes offer valuation services to their clients. Some CPAs are also licensed businss appraisers. While accountants have a strong grasp of the numbers, few have sold a business before. On the other hand, larger accounting firms have dedicated M&A professionals on staff and may be more qualified to prepare a valuation.
M&A Firms – Many Merger & Acquisition firms also offer valuation services to their clients. Many of these firms will provide a simple valuation report and focus on the value of your business in the context of a sale. These firms obviously have experience assisting their clients with buying and selling companies and are well qualified to advise you on the value of your business. Additionally, most middle-market companies' value is established through an auction process. M&A advisors are intimately familiar with this process. They can advise you on the relationship between the price you may achieve through an organized auction process and the number shown in a valuation report.
CPAs and business appraisers are best used when obtaining a valuation for legal purposes. When obtaining an appraisal for legal purposes, you should choose a business appraiser, which is someone that specializes in business appraisals, especially those for legal purposes.
Intermediaries, such as business brokers and M&A advisors, are best used when you want a valuation to help with selling your business, or to help you weigh your exit options. When selling your company, you do not need an appraisal that can be used in court. As a result, the advisor can produce a shorter report, which will save you money. They also have actual real world experience selling companies, which can be invaluable.
Many business brokers recommend obtaining a valuation from a third-party. Brokers make this recommendation because they can sell the valuation at a large markup and do not need the expertise required to appraise a company. Many franchised business broker offices push their franchisees to sell third-party appraisals, which are fairly simple. The business broker often sells the report at a 2-5x markup. The drawback is that you never interact directly with the appraiser.
The methods used to value a small business (less than $5 million in revenue) are different than those used to value a middle-market business ($5+ million in revenue). Unfortunately, most valuation software does not make this distinction, and you sometimes end up with a report that is not suitable. When obtaining a business appraisal, be sure to ask the appraiser the industry and size of businesses they value on a regular basis. You can also ask for a short list of their recent engagements to get an idea of the businesses they usually evaluate.
When obtaining a business valuation, you are simply paying for a professional’s opinion. This opinion is always subject to change. That means that the value they give you is not a tried-and-true price that is the definitive value of your business.
The sale of small and mid-sized businesses is highly inefficient. As a result, values vary wildly. Therefore, the market can greatly affect the final selling price of your business.
Buyers do not always follow valuations. An appraiser is trying to guess what a third-party is going to pay. That task is difficult, especially if the potential buyers for your business are unsophisticated. It is tough to predict what unsophisticated people will do, while it is easier to predict how sophisticated people will act. Buyers of small businesses are largely unshophisticated, while buyers of mid-sized and larger businesses are usually highly sophisticated.
Most appraisals start with an analysis of your financial statements, and a company questionnaire. This data-gathering process is the hard part for you because it involves gathering a large amount of financial and operating information on your company. An appraiser typically needs 3-5 years of your profit and loss statements and balance sheets, in addition to specific information on your company.
Once the appraiser has this information, they will then normalize or adjust your financial statements. This step involves making adjustments to your financial statements, so they can be compared to others within your industry. The appraiser will need to communicate with you during this process and your involvement is key to the accuracy of the appraisal. If they don’t contact you, you must contact them. Don’t be afraid to step up and ask questions during this process.
Once this step is complete, then the appraiser will compile the report based on the information you have given, as well as information the appraiser has already obtained about the industry.
We surveyed a random sample of 44 appraisers, CPAs, and M&A intermediaries, and asked them what their fee would be for appraising a small manufacturing company with $5-10 million dollars in annual revenue. We also asked them if it was necessary to have the company appraised before selling it. Here are the results:
Company #1 – Full-Service Investment Banking Firm - $12,000 - $17,000. The process takes 4-5 weeks. They did not recommend setting a price for the company, as they recommended an auction process with no price. They wanted us to pursue the strategic value rather than the fair market value.
Company #2 – Business Appraiser - $15,000 - $18,000.
Company #3 – Business Appraiser – They have multiple fee structures, starting from a simple report and expanding to a more thorough report, if necessary.
Company #4 – Investment Banker – They did not provide pricing. They said pricing varies based on several factors. They also mentioned attempting to acheive strategic value.
Company #5 – Business Appraiser - $3,000 - $5,000 for a verbal opinon of value; $10,000+ for a written report.
Company #6 – Financial Advisory Group that offers business appraisals – Provides valuations for business sales on an hourly basis. Appraisals for legal purposes are $10,000 or more.
Company #7 – Business Broker & Appraiser – They recommended a “Broker Opinion of Value” and did not provide a price.
Company #8 – Business Appraiser - $12,000 - $20,000. They discussed different standards of value based on the purpose of the valuation. They said the reporting requirements for appraisals for legal purposes, such as estate planning, are more rigorous and mentioned strategies for maximizing cash flow and value.
Company # 9 – Business Appraiser - $2,000 - $3,000 for a calculation of valuation (a very short report). $5,000 - $20,000 for a full business appraisal.
Company #10 – Business Appraiser - $12,000 - $30,000. They can start with a basic report and then upgrade to a more comprehensive report.
Company #11 – Business Appraiser - $7,500 - $10,000 for consulting to determine the value to sell the company. $12,000 - $15,000 to prepare a report for legal purposes.
Company #12 – Publicly Traded Full-Service Accounting Firm- $10,000 - $15,000. The reports are 80-100 pages in length, meant for tax and other compliance purposes.
Company #13 – Solo Practitioner Business Appraiser - $12,500 - $15,000.
Company #14 – Solo Practitioner Business Appraiser - $6,000 - $10,000.
Company #15 – International Financial Advisory Firm - $30,000 - $40,000.
Company #16 – CPA, Business Appraiser – Verbal opinon of value for $2,000 – $3,000. Calculation report for $5,000. Formal report for $8,000 - $10,000.
Company #17 – Business Appraiser - $3,500 - $6,000.
Company #18 – Appraiser, MBA, Economist - $5,000 - $10,000 for a limited report.
Company #19 – Appraiser - $7,500 for a limited appraisal.
Company #20 – M&A Advisor – They said an appraisal was not necessary and recommended we sell the company through an auction process.
Company #21 – M&A Advisor - $5,000 - $10,000 for a valuation or $350/hour.
Company #22 – M&A Advisor – 5% retainer on the estimated amount of the appraisal. Also includes other services.
Company #23 – M&A Advisor – Offers a free valuation for prospective clients.
Company #24 – M&A Advisor – Does not recommend an appraisal.
Company #25 – M&A Advisor – Recommends a third-party appraisal.
Company #26 – M&A Advisor – Does not recommend an appraisal.
Company #27 – M&A Advisor – Does not recommend an appraisal.
Company #28 – M&A Advisor – Does not recommend an appraisal. Does not offer appraisals. This advisor prefers an auction-based process to achieve the highest price.
Company #29 – M&A Advisor – Does not recommend an appraisal.
Company #30 – M&A Advisor – $1,500 - $2,500 for a limited report. $5,000 - $10,000 for a business appraisal.
Company #31 – M&A Advisor – Requires a proprietary report costing $9,500.
Company #32 – M&A Advisor – Does not recommend an appraisal.
Company #33 – M&A Advisor – Does not recommend an appraisal.
Company #34 – M&A Advisor – $6,500 for a business valuation.
Company #35 – M&A Advisor – Recommends a third-party appraisal, costing $10,000 - $15,000.
Company #36 – Business Broker, M&A Intermediary – $10,000 for a valuation.
Company #37 – Business Broker, M&A Intermediary – Recommends a third-party valuation for $4,000.
Company #38 – Business Broker, M&A Intermediary – $2,500 for a business valuation.
Company #39 – Business Broker, M&A Intermediary – $3,000 - $5,000 for an appraisal.
Company #40 – Business Broker, M&A Intermediary – Written opinion for $950 or formal appraisal for $2,500.
Company #41 – Business Broker, M&A Intermediary – $950 - $2,500 for a valuation.
Company #42 – Business Broker, M&A Intermediary – Recommends a third-party valuation - $5,000.
Company #43 – CPA & Business Appraiser– Charges $15,000 for a business valuation.
Company #44 – CPA & Business Appraiser– Charges $5,000 - $7,000 for a business valuation.
If you would like information on valuing your business, please visit our page on business valuations.