Exclusive Interview With Angela Sadang, Accredited Senior Appraiser

How to Get a Premium Value for Your Business

Angela Sadang

ASA, CFA

We recently had the distinctive opportunity to interview Angela Sadang, CFA, ASA, and a Director in the Litigation and Corporate Financial Advisory Services Group at Marks Paneth LLP in Manhattan.Today, Ms. Sadang discusses how to determine what your business is worth, how to get a premium value for your business, using online software to value a business, getting paid for the potential your business has, and so much more!
 

Key Points from our Conversation

  • The best way is to hire a qualified business appraiser to provide professional advice, especially if the value of the company will be used for transactional purposes or any other purpose that needs a supportable reasonable valuation.
  • The purpose of the valuation drives the standard of value and the valuation methodologies used by a professional appraiser.
  • The value of a business is improved with the lessening of risks related to reliance on a few customers, concentration on a few products/services, reliance on key people, limited supply of sources, old technology, and declining sales.
  • Start-up and entrepreneurial idea businesses, with little or no revenues and operating losses are dependent upon private capital rather than public markets.
  • Clearly, understanding the value of a company’s intangible assets is paramount to creating, maintaining, and growing value through better management and protection of these critical assets.

Interview

Tina: How do I find out what my company is worth?

Angela: This depends on the purpose of why you want to find out your company’s worth. The best way is to hire a qualified business appraiser to provide professional advice, especially if the value of the company will be used for transactional purposes such as buy and sale, mergers or acquisitions, reorganizations, liquidations and bankruptcies, spin offs, or any other purpose that needs a supportable reasonable valuation including succession/estate planning, shareholder litigation, marital dissolution, gift/estate and income tax, charitable contributions, and SBA lending.  The purpose of the valuation drives the standard of value and the valuation methodologies used by a professional appraiser. Moreover, professional business appraisers are guided by specific standards and for certain types of business valuations, by specific sets of rules, such as state statutes, IRS regulations, Department of Labor restrictions, or case law restrictions.

On the other hand, if you simply want to get a ballpark idea on your company’s worth to satisfy your curiosity then there are many industry sources that provide “rules of thumb,” or you may look up financial internet sites such as Bloomberg, Wall Street Journal, or Yahoo Finance for trading multiples of publicly listed competitors, if you have any, that have similar operations to your company. However, a rule of thumb or a back of the envelope calculation of an industry multiple is at best merely a sanity or reasonableness check on a properly derived value and can never be relied on alone. As stated in the American Society of Appraisers (ASA) Business Valuation Standard relating to rules of thumb:

Rules of thumb may provide insight on the value of a business, business ownership interest, or security. However, value indications derived from the use of rules of thumb should not be given substantial weight unless they are supported by other valuation methods and it can be established that knowledgeable buyers and sellers place substantial reliance on them.

Tina: I am preparing to sell my small family business. Do I need an appraisal or is that just for big businesses?

Angela: Even if it is just a small family business, you need a professional business appraisal for tax purposes, financial reporting, and equitable distribution of assets among family members or other shareholders, if applicable, and other purposes as stated previously. The buyer, the IRS or other regulatory authorities, or a lending institution will require documentation and substantiation of the standard and premise of value and valuation methodologies used by a qualified business appraiser that form a sound basis for the value rather than something plucked out of the air.

 

Tina: How can I get a premium value for my business?

Angela: A premium value may mean many different things. But you can definitely add premium by lessening nonsystematic risks such as creating synergies with a potential buyer when a company is targeted for acquisition, decreasing reliance on one supplier or one customer, diversifying the product or service lines rather than concentrating sales from one particular product or service, updating technology, equipment, and facilities, exploiting values of  tradenames/trademarks and other intangible assets, and lastly, striving for excellent management expertise and workforce and lessening reliance on one key executive or group of executives.  The key person is considered “key” in any number of business functions. I see most small to medium sized businesses managed by one person who is usually the founder or owner of the business or a key salesperson or sales team driving the sales of the company. Having a key person or key group of persons is both a risk and an advantage. The impact is great when the key man becomes ill, passes away, or retires. But the company can prepare now and resolve succession issues and perhaps command a higher premium for the business when there are initiatives established to develop a well-rounded management that is less reliant on one person or one team.

Having a key person or key group of persons is both a risk and an advantage.

Tina: What are the most important factors that improve the value of a business?

Angela: The most important factors in my opinion are: a) continuous revenue growth which requires continuous product or service innovation and investment in intangible assets, b) diversification of product or service lines, c) optimizing operations, maximizing profits and keeping overhead costs down, and d) a good management team in place that is knowledgeable and experienced in capturing business opportunities.  Investing in a company’s leadership, workforce, and operational effectiveness are also key factors. And as mentioned previously, the value of a business is improved with the lessening of risks related to reliance on a few customers, concentration on a few products/services, reliance on key people, limited supply of sources, old technology, and declining sales.  The tactics that you use to make your company attractive in the market are largely the same ones that direct the company on a path to growth and prosperity, and hence a higher value for the business.

 

Tina: I live in a small town with several pizzerias. One just sold for X amount. Should I use that amount to value my business? From a valuation perspective, why is every business unique?

Angela: This depends on what kind of business you have compared to the pizzeria that just sold for X amount. You may be exposed to the same national and local economic risks, but every business has its unique characteristics and company specific risks. “One size fits all” does not apply here.  For instance, your pizzeria may have more debt while the other has excess cash. Another pizzeria may keep more inventory than the other. One pizzeria may own the real estate or other non-operating assets and rents out excess space while the other leases space. Another pizzeria may have new state of the art kitchen equipment while the other has obsolete equipment. A pizzeria may advertise more aggressively and have established brand logos and brand names that command more loyal customers than the other pizzerias in town. And to value a business, one has to analyze and adjust the financials for unusual items like a pending litigation, an environmental lawsuit, and other one-time charges some of which may not be applicable to the pizzeria that just sold versus your own pizzeria.

 

Tina: I am preparing to sell my business and I would like to sell it in less than a year. Is this a realistic goal? Do you have statistics on how long most businesses take to sell?

Angela: The length of time to sell one’s business follows the law of supply and demand and depends on the industry and the economy and the demand for your kind of business and the products and/or services you offer. There are online sources as to the typical time it takes to sell a business in a specific industry and business brokers will be able to give you statistical data because they are involved with actual transactions in the marketplace.

 

Tina: Do buyers ever invest in an entrepreneurial idea? How do I value my idea?

Angela: There are many different “buyers” of an entrepreneurial idea. Start-up and entrepreneurial idea businesses, with little or no revenues and operating losses are dependent upon private capital rather than public markets. At the earlier stages, seed financing is provided almost entirely by the founder, owner savings, and friends and family.  As the promise of future success increases, and with it the need for more capital, venture capitalists become a source of equity capital, in return for a share of the ownership in the firm and private equity later on.

Many of the standard techniques used to estimate cash flows, growth rates and discount rates either do not work or yield unrealistic numbers. In addition, the fact that most young companies do not survive has to be considered somewhere in the valuation. Therefore, a traditional valuation model is not applicable and cannot be expected to yield reliable valuation indications.  I would use projections based on trends of similar companies or products or users of the entrepreneurial idea and then assess the risks and use a hybrid of a modified discounted cash flow model and relative valuation model using multiples.  I would use a combination of data on more mature comparable companies in the same business and/or industry and the company’s own characteristics to forecast revenues, earnings and cash flows. Discount rates for private capital need to be estimated and the value today needs to be adjusted for the possibility of future failure and other sources of uncertainty. I would also consider the different equity claims in a young company, which can vary on many dimensions that can affect the value.

You may be exposed to the same national and local economic risks, but every business has its unique characteristics and company specific risks. “One size fits all” does not apply here.

Tina: Can I use online software to appraise my business? What are the risks/benefits?

Angela: There are many online software programs out there but beware because you get what you pay for. You cannot consult with nor communicate with online software and since you get cookie cutter outputs, you have to question whether output produced by online software programs is really credible and reliable. If it goes to a regulatory authority such as the IRS or used in litigation, it is best to use a qualified business appraiser.

 

Tina: Can my CPA/accountant value my business?

Angela: Accountants have a distinct advantage in their understanding of financial statements, concepts, and terminology, revenue ruling, and tax laws. However, accountants are used to concepts that are tax oriented or GAAP oriented rather than concepts that involve fair market value or forecasting future operational performance. Accountants also have to be concerned with potential conflicts of interest and bias in valuation assignments. 

That said, accountants, engineers, college professors, economists, Ph.D.s, financial analysts, investment bankers and other professionals have all made claim that their skills are most relevant to business valuation. All their skills are relevant to the discipline and business valuation is a multidisciplinary exercise. No sure set of qualifications or credentials or academic achievements grants monopoly to practice business valuation. Logical thinking and analytical reasoning as well as mathematical skills are essential, however, the better professional business valuation professionals are those who have obtained advantages over other groups by providing business appraisal services as their main area of focus and daily practice, being generally well educated in business valuation, and having received some form of accreditation from a professional appraisal organization such as the Accredited Senior Appraiser (ASA) designation from the American Society of Appraisers and the Accredited in Business Valuation (ABV) designation from the AICPA. Having credentials in business valuation also indicates that the professional adheres to certain business valuation standards and guidelines including ethical guidelines.

 

Tina: Do I need a separate appraisal for my intellectual property?

Angela: Yes, you definitely need a separate appraisal for intellectual property.  Over the past 20 years it has become increasingly and, continually, more apparent that large and small companies must focus on the development and maintenance of intangible assets as most developed economies have moved from a “bricks and mortar” economy into one more driven by intangibles.  Public corporations now derive between 70% and 80% of their value from intangible assets that include logos and product symbols, proprietary technologies, Internet domain names and trademarks, customer relationships and customer lists, order backlogs, licensing rights, royalty agreements, franchise rights, patents, trade secrets and know-how. The same is true for small and medium sized private companies. Clearly, understanding the value of a company’s intangible assets is paramount to creating, maintaining, and growing value through better management and protection of these critical assets.

Logical thinking and analytical reasoning as well as mathematical skills are essential.

Tina: Can I get paid for the "potential" of my company?

Angela: The “potential” of the company can go into different directions and the market determines if there is value for the potential of your company. Valuation at the start up stage is all about growth potential. This is similar to the question of whether there are investors in an “idea.”  Technology companies such as Facebook, LinkedIn, Alibaba, WhatsApp, Uber, to name a few, all started with an idea and a potential. 

Generally, investors at whatever stage assess the company's value based on the phase of development of its products and services. The value of a company may increase even though the company sustains substantial and continual losses, and holds a portfolio that is far from being marketable. As the company progresses through its life cycle toward becoming a viable company and its products and services proceed through successive milestones, the value of the company increases along with its underlying "potential value."

Value indications may come from a matrix of comparable companies and recent financial and development phase information. Value indications will consider factors such as potential market size, likelihood of governmental approval, projected introduction date of a company's developing products, products/services under development and, most importantly, the corresponding development phase for each product. Since start-up companies seldom generate sufficient cash flows to support their R&D projects, they must rely on invested capital in order to advance their products and services. As the product development continues and assuming there are no failures, the certainty of success and of receiving the anticipated cash flows increases substantially, resulting in a corresponding increase in the company's value. The amount of invested capital is an indication of the magnitude of its value since it could not have reached its current state of development without the investment of such capital.

 

Tina: Do you have any other tips of advice for anyone buying, selling or appraising a business?

Angela: The appraisal of a business is neither strictly an art nor a science but a hybrid of both. It is not an exact science in the sense that no precise relationships exist to measure precise and certain outcomes but it is a science in the sense that it involves mathematics, statistics, economics, and logical and analytical reasoning. It is an art in the sense that it requires skill, knowledge and experience to apply subjective sound judgment on the facts. Ultimately, the market determines the value of a business and a business appraiser’s role is to reasonably and logically estimate that value.

 
 
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