Exclusive Interview With Jerry Horton, Certified Business Appraiser

Jerry Horton

MS, MBA, CBA, Ph.D.

In this interview, we discuss exit planning, business appraisals, valuations, normalized salary, working with a CPA, Business appraiser, and Attorney, and more. Dr. Horton has owned, operated and started several high tech businesses in the past twenty-five years and has many years of experience performing forensic accounting on seller’s financials, analysis of financials during due diligence phase of acquisition and business valuations.

Key Points from our Conversation

  • The only way to set the price [of your business] is to perform a business appraisal.
  • If you are selling a business, a broker who has been trained if performing valuations will suffice. Otherwise you will need a certified business appraiser.
  • Selling a business requires three years of financials statements plus, for each year, a list of personal or owner benefits you have received from the company.
  • In any case, if the Seller finances a large part of the acquisition then he or she should be prepared to take the business back in case the buyer defaults. If the Seller is not prepared to do that then he should not extend Seller financing.
  • It is important to use your lawyer to deal with drafting and analyzing the legal documents.

Interview

Tina: What role does a business appraisal play in exit planning?

Jerry:  Before you can offer your business for sale you must determine a reasonable asking price. The only way to set the price is to perform a business appraisal.  This must be performed by a professional who has been trained in appraising of business. If you do not know what the value is, you cannot accurately set a market price that attracts buyers to purchase your business.

Also, in preparation to sell, you must make sure you really want to sell and what your exit strategy will be. Clearly know why you are selling and be prepared to communicate that reason to a buyer without hesitation. Have a transition plan for your next steps, whether it be retirement or another endeavor.

 

Tina: What are some reasons I might need to appraise my business?

A:  Business appraisals are needed in selling your business, tax planning, estate planning and divorce ligation.  There are numerous reasons to have a business appraisal.

 

Tina: What does an appraisal cost and how long does it take?

Jerry: If you are selling your business, many business brokers will perform an appraisal as part of listing your business for sale. That is typically done as no charge. For other situations such as tax, divorce or estate planning, where a certified business appraiser is needed, the cost can range from $7,500 to $30,000, depending on the size and complexity of the business.

 

Tina: What type of business appraiser do I need? Are there different types of appraisers?

Jerry: If you are selling a business, a broker who has been trained if performing valuations will suffice. Otherwise you will need a certified business appraiser. There are business appraisers who may specialize in different areas but generally a certified business appraiser can perform a wide variety of types of appraisals and businesses. There are only few organizations that certify business appraisers and the training provided in these organizations encompasses all types of appraisals with all types of businesses.

Now, if your business owns real estate and you intend to sell the real estate you will need a certified property appraisal and, if needed, an environmental study. If there were no conditions that warrant an environmental study then you might not need it. If you have had an appraisal and environmental study done in the recent past this should suffice.

 

Tina: My business is losing money, would anyone still be interested in acquiring my business? Why?

Jerry: There may be buyers who are interested in the physical assets of your company. You may have to perform an equipment and machinery valuation of these assets to determine a reasonable market value for these assets. You may also have value in the name, location or branding owned by your company that would make it have value in the marketplace. Most businesses are sold as going concerns and their value is primarily determined by their profitability. Exceptions can be those companies that have a large amount of physical assets or trademarks, copyrights or patents.

If you do not know what the value [of your business] is, you cannot accurately set a market price that attracts buyers to purchase your business.

Tina: What information do you need to prepare a valuation for my business?

Jerry: Selling a business requires three years of financials statements plus, for each year, a list of personal or owner benefits you have received from the company. Examples of benefits are personal use of cars, phones, vacations, etc..

 

Tina: Will buying new equipment improve the value of my business?

Jerry: If you have equipment that needs replacement or maintenance then you should replace or refurbish the equipment to insure it is operational. A good example of this may be refrigeration units for produce companies.  Poor conditions of equipment may cause a buyer to reject purchase of your business. In general, new equipment will not impact the overall value of the business except where it may increase the company’s profits.

 

Tina: What's the best way to value a company when an owner is being bought out?

Jerry: The most straight forward method or approach is to determine valuation as you would in selling all of the company. The value is the same as though the company is being sold in the open marketplace. However, if you are only valuing part of the company where there are minority stockholders, then you will no doubt need a certified business appraiser who has the training and expertise in valuing minority interests in a company. It can be complex problem valuing minority shares.

The most straight forward method or approach is to determine valuation as you would in selling all of the company.

Tina: Will I have to finance the sale of my business? Are there any statistics regarding this?

Jerry:  In order to sell many small businesses, especially restaurants, the seller will have to hold paper to complete the transaction. No doubt most small businesses are sold this way.

 

Tina: Why is seller financing so important to the sale of my business?

Jerry: Seller financing can be important depending on what type of business you have. If it is a small restaurant then likely the seller will have to hold paper. In many transactions the buyer will require some financing of the business as security to insure the business performs as advertised by the seller. In any case, the Seller should attempt to collatorize the loan in some way with assets outside the business. The Seller should assess whether he or she should loan the money to the buyer and that the buyer has the experience and knowledge to make the business a success. One strategy is to negotiate that a high percentage of the purchase price is paid in cash at closing if that is possible or, alternatively, encourage the buyer to seek out a small business loan (SBA) as an alternative in financing the transactions if the business can qualify to an SBA loan. In any case, if the Seller finances a large part of the acquisition then he or she should be prepared to take the business back in case the buyer defaults. If the Seller is not prepared to do that then he should not extend Seller financing.

 

Tina: What does it mean to "recast" my financial statements?

Jerry: Recast simply means that the payments to the owner of personal benefits, interest payments, depreciation and expenses that are not recurring are removed from the expenses in the income statement to determine the true profit or cash flow of the business on an ongoing basis.

 

Tina: What is the rationale behind adding back Interest and Depreciation when recasting earnings?

Jerry: The interest is added back because the buyer will not have the same interest payment as the seller. As an example, the buyer may pay cash for the business without having any debt and therefore will incur no interest expense in the business. Interest needs to be removed because the buyer will not have this same expense. Depreciation is simply an accounting expense required for taxes and does not directly impact the cash received by the buyer for operation of the business. Depreciation of equipment must be considered if you are selling an equipment rental company – in this case real depreciation and use of the equipment comes into play.

 

Tina: What is considered a normalized salary and how is it relevant in determining business value?

Jerry: The normalization of salary is the comparison of the salary paid to the owner versus what is typically paid to a manager for the same functions the owner is performing. If the owner is being paid in excess of the typical salary then there is an added benefit, the difference, or profit that must be added back.  If paid less, then there is an extra expense of the added to the expenses: the difference between the normal salary and salary actually paid to the owner.

 

Tina:  What is your advice on selecting a lawyer to support selling or buying a business?

Jerry: You will need a lawyer at the time you either receive a letter of intent from a buyer or, if you are a buyer, when you are drafting a letter of intent. If you are not using a letter of intent and going straight to a contact, you will need a lawyer if you are either a buyer or seller. You must select a lawyer who has some experience in dealing with business acquisitions. There are generally a select few in each community. It is important to use your lawyer to deal with drafting and analyzing the legal documents. He or she should focus only the legal aspects and provide legal advice. Do not let your lawyer be involved with the negotiating the business terms of an acquisition, have him or her focus only on the legal aspects of the contract. You and your broker will have the best background to negotiate business terms and will have the highest probability of success for the transaction.

 

Tina: What do I need to know about the work and methodology of selling my business?

Jerry: First of all, realize that you are always selling. It is your job and your broker’s job to sell your business. This means always communicating in a positive manner. Always focus on the advantages and what is good about your business. Any business will have its good points and bad points. Never describe your business in a bad light. However, always be honest in answering questions from a buyer. At the same time, always assume the buyer is smart and will, by his or her due diligence, learn about your business during the acquisition process. A final word of advice: always sell the future – communicate your future expectations of the business and where this business can go. Buyers are buying the future so you have to implant the vision of where the business is going in their head. That vision must always be a good one. Remember you are always selling.

First of all, realize that you are always selling. It is your job and your broker’s job to sell your business. 

Tina:  What type of broker should I select?

Jerry: You will need a broker who can give you his full attention and will provide a customized consulting service as well as experience in selling and buying businesses. Preferably, get a broker who only has a few businesses listed so he or she has the time it takes to sell your business.

The broker should be someone who should has owned several businesses and who has sold his or her own business and is certified as a business intermediary.  If possible, your broker should also have certification in business appraisals or extensive experience in valuations. The broker should have extensive experience performing financial analysis and be good with details – the numbers will ultimately determine whether you will sell your company or not.

Selling your business is not a MLS activity. It must be confidential, there should only be a broker, the buyer and the seller involved in getting a deal done. All three must work as a team to reach an agreement that everyone can live with. The more people that are involved, the more difficult it will be to reach a deal and to maintain confidentiality.

 

Tina:  What do I need my accountant to do?

Jerry:  Your accountant will work in a supporting role during the process. First, if you are the seller, the accountant must produce the financial statements requested by the buyer. He must also answer any detailed questions the buyer may have – typically, you will communicate these questions and answers to and from your accountant while your accountant works in a support role. If you are a buyer you may have your accountant analysis the financial data supplied by the Seller. This may be simply the financial statements or, during the due diligence stage, it could be examination of the data within the accounting system. For both buyer and seller, your accountant can and will provide advice on taxation issues associated with the transaction.

 

Tina: Do I have to worry about having a stock sale versus asset sale?

Jerry: In an asset sale the buyer is purchasing the assets of the company and transferring the assets into a new company. Many times the old company is renamed and the new company may take the old name of the company. In an asset sale the buyer does not incur any risk of being sued or liabilities that may exist because he or she has formed a new entity. In an asset sale the buyer usually pays for inventory at closing.  Also in an asset sale the Seller unusually pays for the payables and other liabilities at closing so the assets are sold debt free.

In a stock sale the buyer purchases the stock in the old company directly. Theoretically the buyer gets everything at closing. Of course this is determined by the offer and subsequent negotiations. To guard against unforeseen liabilities, the sales contract will contain the necessary strong legal language to attempt to shield the buyer from these unforeseen contingencies.

Most transactions are asset sales. One of the reasons for a stock sale is for tax purposes. If the company is a C corporation then the seller may incur a double taxation on a corporate level and personally, which in some cases make it infeasible to perform the transaction. In a stock sale this double taxation situation does not occur for C corporations. Many times, corporations will transition from a C corporation to a S corporation over a period of years to avoid this problem.

Any business will have its good points and bad points. Never describe your business in a bad light.

Tina: As a seller, what should I do to prepare my business before listing it for sale?

Jerry:  There are many things a seller can do to prepare for selling their business:

  • Make sure you have the financial information available for buyers to evaluate the business. Typically, this requires three years of financial statements. For many small companies this can be financial reports from Quickbooks and for larger companies this will be financial statements from Accountants.
  • Many times buyers want to also see tax returns, mainly to verify the financial reports. Tax returns for a company are designed to minimize taxes, not necessarily show the true profit of a company, and that is why the financial statements are also needed. Accrual based Balance Sheets and Income Statements are what is needed. It the financials are kept as a cash basis they will have to be adjusted to accrual basis during the acquisition process.
  • If possible, the company’s operation should be designed to minimize the time and need for the owner. It may take some time to train people, modify the organization structure and to change procedures, but it will make your company much more desirable in the market place.
  • It is always a good idea to assess the strengths and weaknesses in your business before listing the business. Identify the “hot buttons” that make your company stand out.  Also think about what kind of buyer would want to buy your business and why. In preparing your listing you can target buyers with a clear communication of the strengths of your company.
  • If you are leasing your property then you need to evaluate your lease to see if it can be assigned or evaluate whether the buyer can obtain a lease at the current location.
  • It is very important to get written agreement by all stockholders or partners to sell the business before putting the business on the market. The agreement should be clear what each partner or stockholder will receive at the beginning of the process. This cannot be left as an open item.
  • If you are taking significant amount of cash from the business without recording these sales into the accounting system, then you should delay listing the company for one year and then record this extra income into the accounting. If it is a large amount of cash, it can mean a large amount of money you will receive for the business at the end of the day.

Finally, you must understand that the process will take time, require patience, cost money in accounting and legal fees and you must focus your attention to achieve success in selling your business. Sellers and buyers must understand that there may be considerable amount of stress and fortitude to succeed. This should be understood from the beginning. A good and experienced business broker can go a long way to reduce the stress and uncertainties of selling your business, but cannot eliminate them.