Today we were given the opportunity to interview Mr. Van Horn, the president and founder of Business Appraisal Services, LLC. Mr. Van Horn has over 23 years of business valuation experience and has been involved with over 3,000 valuation engagements. In this interview, Mr. Van Horn discusses various aspects of appraisals, such as real estate appraisals, appraising a minority interest, when to get an appraisal done, and the benefits of having a business appraised.
Tina: Is there a right or wrong time to have my business appraised?
Brad: While there is never a wrong time to have your business appraised, you should maintain an updated appraisal as part of your estate plan. Generally, you should have your business appraised or previous appraisals updated any time there is a significant change in your business or in the industry you participate – or at least every other year.
Tina: I am a buyer, how do I know if I am paying too little or too much for a business?
Brad: Unless you are a sophisticated investor, paying too little or too much, may be a relative term. The best thing you can do to determine a fair price is have the company appraised by a qualified, independent third party. Calculating a fair value based on the cash flows the business is capable of generating in the future is a critical component of the valuation process.
As a buyer, you may not be granted access to the type of information required to perform an accurate business appraisal. As a result, you need to ask yourself “what am I buying?’ In other words, is the real value of the company in the equipment and other assets it owns, in its customer lists, patents, key employees or other identifiable assets?
Once you have determined what it is you are actually buying, you need to think about what it might cost you if you were to go out and buy those components individually, and whether you can actually accomplish this. Don’t forget to consider opportunity costs and the time and effort it may take you to buy those components individually as opposed to buying all the components in one transaction, meaning buying the business.
Depending on the type of company, this may be a simple answer or a very complex answer. You also need to determine who legally owns the real-estate, as the real-estate may be the largest asset purchased in the transaction.
The best thing you can do to determine a fair price is have the company appraised by a qualified, independent third party.
Tina: What methods do you use to appraise a high potential startup with no revenue? For example, an online company with $500,000 invested in web development with positive revenue, no profitability but high growth ahead.
Brad: There are several types of financial models that a qualified business appraiser should be familiar with that can assist in determining the Fair Market Value of a start-up company. Some financial models include an analysis of “Option Pricing” and “Forecasted Cash Flows”. A qualified appraiser should also have access to market data, which offers valuable insight to what people are actually paying for similar types of businesses and expectations of the transaction for a specific industry. Just because a business has yet to generate revenues or profits does not mean the business is not marketable or does not have economic value.
Tina: In many lower middle-market businesses, investment bankers do not recommend an appraisal. Do you feel a business appraisal is necessary for companies looking to sell in the lower middle market ($5-50 Million in Annual Revenue)?
Brad: I believe that “lower middle-market” businesses have a greater need for an appraisal than large companies or publicly-traded companies, for the simple reason that there is a lack of readily available information for small companies compared to the information available for larger companies. Large companies have sophisticated management structures, diverse customer bases, access to capital, and several competitors who provide the same service or product.
Determining the value of a small or mid-market business is much more complicated and often requires the application of a significant amount of professional judgment in addition to market based facts. One of the reasons investment bankers may feel an appraisal is not necessary for small mid-market business is because many small and mid-market businesses sell for a price that takes into consideration many non-financial factors, and even emotion, rather than being based solely on financial fundamentals.
And while a business appraisal may result in an opinion of value that is much lower than the realized transaction price, the point is most valuations determine a Fair Market Value, which should serve as a minimum benchmark for a transaction price. Basically, an appraisal says “don’t accept anything less than this price, but you may be offered a lot more than this price” based on synergistic factors that enhance the value in the hands of the buyer.
I believe that “lower middle-market” businesses have a greater need for an appraisal than large companies or publicly-traded companies, for the simple reason that there is a lack of readily available information for small companies compared to the information available for larger companies.
Tina: Is a business appraisal for a minority interest different than for that of an entire business?
Brad: While the process of determining the value of a minority interest requires the same level of due diligence and financial analysis as a transaction involving the entire business, the economic characteristics associated with the ownership of a minority interest are far different than the economic characteristics associated with owning 100% of the company. Differences in these economic characteristics have a significant impact on value. When you are valuing a minority interest, you cannot make “control type” adjustments to the cash flows, as a minority shareholder does not have the ability to change the cash flows the way a majority owner could.
Also, when valuing a minority interest there needs to be a thorough analysis of the application of appropriate discounts for “lack of control” and “lack of marketability,” which can be much larger than a control based interest. In fact, a minority interest value can often have valuation discounts of 40 to 50% applied to the enterprise value, compared to a control based interest which may have discounts as low as 5 or 10% applied to the enterprise value.
Tina: If I also own the real estate, is it necessary to have my business and real estate appraised separately?
Brad: We will assume that the real estate is used to operate the business. While it may not be necessary for every transaction, it is very often recommended that both the business and the real-estate be appraised separately. While many of the techniques involved with valuing a business are similar to the techniques utilized in valuing a piece of real estate, the professional certifications and qualifications are different.
It is often a good idea to have the real estate appraised because the real-estate may be worth more than the “going-concern” or operational value of the business. Also, transactions can be structured in various ways, which may include separating the real estate into a separate entity and rented to the operating company or the seller may wish to keep the real estate and rent the facilities to the new buyer.
While there is never a wrong time to have your business appraised, you should maintain an updated appraisal as part of your estate plan.
Tina: When should I plan to begin the succession planning process?
Brad: Yesterday! It is never too early to start the succession planning process and constantly knowing and understanding the value of your business is very important. We have observed that the most common form of business succession planning is to do absolutely nothing, which is unfortunate. For most business owners, their business is the largest asset of their estate and without the proper succession plan in place, the blood, sweat, and tears you shed will be going to Uncle Sam rather than you or your heirs.
This is exactly why every business owner needs a business valuation and needs to update the valuation on a regular basis. How else can you plan your retirement if you do not know what your assets are worth?
Tina: If I am thinking about exiting my business, what are my options?
Brad: What many business owners do not know about this question is there are several options beyond just putting the business up for sale. Another issue many business owners do not realize is no matter what decision is made, a taxable event will occur and some simple planning can mean the difference between going broke (in extreme circumstances) and having a large windfall.
Some possible options include:
All of these options should be considered by the business owner, and the best option is the one that meets the business owners personal needs or goals, but again do not forget any decision will result in a taxable event and simple planning can make all the difference.
Tina: What are your comments regarding the language in buy-sell agreements pertaining to the value of the business, or getting the business appraised in the future in the event of a potential issue?
Brad: The majority of the language of a buy-sell agreement should be left to your attorney, however details as to determining the value of the company need to be addressed by BOTH an attorney and a qualified business appraiser. I would say nearly all the buy-sell agreements we have seen are vague and/or silent as to the methods, standard of value, application of valuation discounts, and valuation date, which are all critical points that need to be specifically addressed in every buy-sell agreement.
One point to keep in mind is that including a formula as to how the business value will be calculated is considered irrelevant for tax related transactions, and can even be considered irrelevant for court cases, whereas Fair Market Value is all that is relevant for tax purposes and statutory definitions of Fair Vale and Fair Market Value are all that is relevant for most court cases.
I would say nearly all the buy-sell agreements we have seen are vague and/or silent as to the methods, standard of value, application of valuation discounts, and valuation date, which are all critical points that need to be specifically addressed in every buy-sell agreement.
Tina: When does a business need a buy-sell agreement? Is this a common issue you encounter? If so, what advice do you have for business owners?
Brad: Unfortunately, many businesses we have valued over the years do not have any sort of buy-sell agreement in place. And the businesses that do have a buy-sell agreement in place lack many of the important considerations that need to be addressed in the event of buy-out. Every business with more than one shareholder should have a buy-sell agreement signed, dated, and fully enforceable. The existence of a buy-sell agreement will alleviate many of the problems that inevitably occur when a shareholder desires to terminate his relationship with the company, or if a shareholder dies and the company must now deal with his estate.
Tina: What happens if I need to, but cannot afford to, buy out one of my owners?
Brad: Depending upon the circumstances of the buy-out you may want to consider having key-man life insurance or disability insurance in place should the need arise. There are many buy-out structures that can be implemented, which is why making sure the terms of the buy-out are addressed in your buy-sell agreement is very important.
Tina: Should I have my financial statements audited if I am thinking about selling my business?
Brad: Audited financial statements are not required to be able to sell your business. For some businesses, audited statements could really be a waste of money. For some businesses, just having the balance sheet audited or certain accounts audited, such as accounts receivable or inventory audits, may provide enough security to a potential buyer.
Tina: I am selling my business; will I be responsible for financing the sale?
Brad: Not necessarily, and in fact your accountant may suggest financing structures which are more tax advantageous. The right financing for the transaction would be determined on a case-by-case basis.
Tina: Why does it cost so much and take so long to have my business appraised? What are the benefits of having my business appraised?
Brad: These questions are all relative. Some firms charge $2,500 for a valuation and can get the job done in a week, while some firms charge $50,000 and need months to complete the valuation. The most important factors that need to be considered when choosing a valuation professional to appraise your business include:
The right financing for the transaction would be determined on a case-by-case basis.
Tina: Do you have any other tips of advice for anyone buying, selling or appraising a business?
Brad: If you are involved in buying or selling a business make sure you:
If you are appraising a business make sure you are qualified to perform the valuation and maintain your compliance with the applicable standards of your credentials. Regardless of the purpose of the valuation, perform the appropriate amount of due diligence and make sure your valuation report would be up-held in a court of law. If the report could not stand up to opposing criticisms, the report is probably not to the quality your clients deserve.