Business Appraiser Interviews

Get a Better Return on Investment by Planning Ahead

Key Points from our Conversation

  • To fully maximize the value of your investment in a company, consider a valuation three to five years in advance of selling.
  • An appraisal is a snapshot in time, so any material changes to the condition or performance of the business will change the value indicated.
  • Other specific items which drive premium valuations include recurring revenue streams, defensible market niche, broad customer base, and lack of reliance on the shareholder for the performance of the business.

Interview

Tina: I am ready to sell my business. How do I know how much my business is worth?

Dan: First, I would suggest if you are ready to sell your business you should already know what your business is worth. Selling a business is a big undertaking which is often the culmination of your life’s work. Waiting until you are on the cusp of a sale is not the right time to start wondering about value.  To fully maximize the value of your investment in a company, consider a valuation three to five years in advance of selling. 

 

Tina: I have an idea of the amount I want to sell my business for. I also know the potential buyer will have my business appraised. Do I need to have my business appraised before I sell it? Can I rely on the buyer’s appraisal to see if my price is too high? What advice do you have?

Dan: This depends on your comfort level with the nuances regarding valuation. Have you sold a number of businesses in the past? Do you have a solid understanding of what drives value? Have you undertaken a process to improve value pre-sale?  If so, you may not need a valuation. 

Likewise, if you have an M & A advisor working on your behalf who can help you throughout the process. 

If this is your first sale, if you are un-advised, or if you are less comfortable with the nuances of valuation, undertaking your own independent valuation is a good idea. An investment in a certified valuation can potentially keep you from a very costly mistake, which will be all but impossible to rectify.

If this is your first sale, if you are un-advised, or if you are less comfortable with the nuances of valuation, undertaking your own independent valuation is a good idea.

Tina: Why would I need my business valued for non-legal purposes, other than general exit planning and to sell my business?

Dan: You would need it valued for a myriad of reasons. The most typical of those include:

  • As part of a buy-sell agreement (bringing in a partner, exiting a partner, etc.)
  • Litigation (to include damages, lost profits, etc.)
  • Divorce (i.e. the business is a marital asset)
  • 409(a) compliance (you have issues stock options or equity compensation and triggered a valuation requirement under IRS rule 409

 

Tina: Is there a difference between an “appraisal” and a “valuation?”

Dan: There is not much difference between an appraisal and a valuation. Both are opinions of value. People more frequently refer to appraisals in the context of real estate. However the terms business appraisal and business valuation can be used interchangeably.

 

Tina: Do you need to visit my business to complete the appraisal? What information will you need from me to complete the appraisal?

Dan: Most often we can complete an appraisal remotely with minimal interference to the day-to-day performance of the business. This is especially so for service businesses where value is driven by people and processes rather than by productive physical assets. Modern technology helps us all work remotely. We typically will only work onsite if there is a compelling reason to do so. 

The basic appraisal process remains the same whether you have a distribution business in Des Moines or an online business working across the globe.

Tina: Can you appraise my online business if I have clients located all over the world, or if there is an international component to my business?

Dan: We can appraise your online business as well as any international components of the business. Online businesses are unique, but we deal with them quite frequently. The basic appraisal process remains the same whether you have a distribution business in Des Moines or an online business working across the globe. 

 

Tina: Is it ethical for an appraiser to help me sell my business?

Dan: This is a gray area. We do not work that way. We view ourselves as independent and unbiased, separating ourselves from a sale. I am certain many appraisers can be unbiased and sell a company, but it is not the way we prefer to work. 

 

Tina: I have a twenty-year-old corporation with a strong D&B rating. Is it worth any money?

Dan: Sure, a strong D & B rating may be worth money.  However, we cannot really answer that based solely on a D&B rating. 

In the absence of an affirmative requirement in a shareholder or operating agreement, it is unlikely you would be obligated to share your valuation.

Tina: I want to find out what my partnership in a business is worth. Do I have to show my partners the appraisal?

Dan: You likely do not need to show your partners the appraisal. In the absence of an affirmative requirement in a shareholder or operating agreement, it is unlikely you would be obligated to share your valuation. In our practice, we often work on behalf of one party in a shareholder breakup without ever speaking to the other side. 

 

Tina: How long is my appraisal "up-to-date" or “current?”

Dan: We generally say about one year. This is also consistent with the American Society of Appraisers (ASA) guidance. An appraisal is a snapshot in time, so any material changes to the condition or performance of the business will change the value indicated.  If you have had an appraisal completed and want to know if it is still valid, consult with your valuation firm.

 

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

Dan:  First, plan for an exit. This is a multi-year process, wherein if you identify and mitigate risks you can push your relative valuation higher. Other specific items which drive premium valuations include recurring revenue streams, defensible market niche, broad customer base, and lack of reliance on the shareholder for the performance of the business. 

 

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

Dan: It is probably apparent from the above, but we are big believers in starting early and being diligent in your preparations. While the cost of a valuation is not insignificant, there is an incredible return on investment (ROI) in establishing value early and then putting together a concrete, definable plan to achieve your desired exit value. Consider it this way: a company which proactively plans an exit may spend 10-20-30 thousand dollars in preparation. They often see hundreds of thousands of dollars in increased sale proceeds. Can you get a ROI of $10,000 to $20,000 in the stock market? We do not think so.

Protecting Your Business Through Due Diligence

Key Points from our Conversation

  • When real estate is involved, always pay sufficient attention to the tax implications on the valuation and possible transaction.
  • When you are a financial buyer, one who is primarily interested in the stand alone proceeds from the target company, you will need to formulate your expectations with regard to cash flow and capital gains in advance.
  • To protect yourself from paying too much you should invest in a comprehensive business valuation before you make an offer.
  • It is a good thing to think about your funding source early in the process of buying a business and speak to some bankers to get a sense of their appetite to fund your acquisition before you invest in a business valuation or a due diligence process.

Interview

Tina: I am a buyer, how do I know if I am paying too little or too much for a business? How can I protect myself from paying too much?

Walter: Well, too little is hard to imagine. In my opinion, there is no such thing as too little when it comes to buying a business. I can only think of a seller who is not in the right capacity (mentally or physically for instance) to make appropriate decisions about selling his or her business. In such a situation, as a buyer, you should consider if it is ethical to buy a company for a price so low it is not realistic. This could backfire down the road.

You know you are paying too much when the price will prevent you from reaching the goals you set in advance with regard to the specific transaction.

When you are a financial buyer, one who is primarily interested in the stand-alone proceeds from the target company, you will have to formulate your expectations with regard to cash flow and capital gains in advance. This is a prerequisite to assess if the forecasted return from that business will be meeting your targets. You will have to assess the specific risks of the business as well as the industry in the business is a part of.

If you are a strategic buyer, one who wants to consolidate existing businesses with the target business or one who wants to take out a competing business, you should estimate what the impact will be of buying the target company. This will need to be done both stand-alone and after integrating the target business in your existing group of businesses, which are called “synergies.”

In general, to protect yourself from paying too much, you should invest in a comprehensive business valuation before you make an offer and in a thorough buyer’s due diligence after the offer has been accepted. In other words, your offer should be subject to a satisfactory due diligence.

 

Tina: If I also own the real estate, is it necessary to have my business and real estate appraised separately?

Walter: In general, I would answer this question with a yes. As a valuator, I usually appraise the business and the real estate separately.

When appraising the business, you will have to ‘normalize’ the income statements of that business, inserting an at arms length lease amount that would have been paid in case the business was not the owner of the real estate as a business expense.

When appraising the real estate, you usually consult a real estate appraiser. However, when appraising a real estate company, one that is primarily leasing office space or apartments, you will appraise the business yourself as well. For instance by analyzing the market rental value of the lease agreements that the real estate company has in place.

When real estate is involved, always pay sufficient attention to the tax implications on the valuation and possible transaction.

I believe there is also a trend in the market now which questions whether a business should own the real estate it uses as its place of business. That is another benefit of having your real estate valued separately, it could give you a better view of whether it complements or actually weakens your business (valuation).

 

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.

Walter: Since this startup will not have a proven track record, your effort will be primarily in the thorough review of the forecasts of the business and the underlying assumptions leading to these forecasts. Since startups could be highly risky, with a significant possibility it will fail all together, understanding and assessing the risks is imperative.

Since less quantitative information is available, you will focus more on qualitative information. For instance, the track records of the owners and key staff, the growth potential of the business and the industry or market it is targeting, the funding of the business etc.

In your valuation report, you will be using more and more extensive disclaimers and your value ranges would be broader than usual.

It [business valuation] will provide you with a strong baseline on the current value of your company and can help you to improve the value of your company in the remaining years before the exit.

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)?

Walter: In my opinion, a business valuation is always a good investment for a seller. An experienced professional will explain to you the value of the company and the strong and weak points he has discovered and which form the basis for the resulting valuation amount.

As a seller, you will be better prepared for the price negotiations.

It would be even better to invest in a business valuation at least two or three years before your desired exit date. It will provide you with a strong baseline on the current value of your company and can help you to improve the value of your company in the remaining years before the exit.

 

Tina: I am looking to buy a business. How can I secure funding for the purchase? Do I have to go through a bank?

Walter: No, you don’t have to go through a bank. A bank could provide you with part of the funding, but normally a bank will never fund a transaction for the full 100 percent. In my experience and in the markets where we are active, a bank will require at least 30 percent or 40 percent equity to fund the transaction amount.

There are other sources of funds available, like private investors, family members, private equity funds etc. It primarily depends on your own reputation and track record, your net worth, the quality of your network of funders, the “bankability” of the business you intend to buy, etc.

The better you prepare yourself, the more you will improve your odds to get financing from third parties. For instance, by doing a thorough industry analysis, by getting a professional business valuation and in-depth due diligence.

Going to the bank is the most common source of funding for entrepreneurs looking to buy a business. It determines the feasibility of a valuation. You could have a great valuation report prepared and a willing buyer lined up to execute the transfer of company at an agreed price, but if the bank is not willing to finance it, the deal could fall through. It is a good thing to think about your funding source early in the process of buying a business and speaking to some bankers to get a sense of their appetite to fund your acquisition before you invest in a business valuation or a due diligence process.

 

Tina: If I am thinking about exiting my business, what are my options and when should I start planning for this?

Walter: Exiting your business needs careful preparation. A well-prepared exit could take as many as three to five years. Some successful business owners even claim you should already know your exit strategy before you start your business!

In general, the value of your business will be higher when you prepare your exit well, which should result in a higher selling price.

Our company, The Curacao Financial Group, assists business owners who want to make an exit through our Value Improvement programs. We do this in cooperation with The Sellability Score and The Value Builder organization.

  1. First of all, we invite the business owner to take the Sellability Score questionnaire, which will result in a score from 0 to 100 on their “sellability.” The higher the score, the better the owner’s chances to make an interesting exit. Interested business owners can take this questionnaire using the following link: http://score.valuebuildersystem.com/the-curacao-financial-group-nv/walter-blijleven.
  2. In case the initial score is relatively low, we offer the owner to engage in the Value Improvement Program, which is based on the Value Builder system. The essence of the Value Builder system is explained in the following 90-second video: https://vimeo.com/118753122.

It is better to know your weaknesses and solve them in advance.

Tina: What is due diligence and how will this affect the sale of my business?

Walter: When you as a seller or a potential buyer of your company wants to execute due diligence on your business, it means thorough investigation to all material aspects of your business will be necessary. This is not restricted to the financial records of your company, but it will also include all important commercial, legal, human resource, IT, and environmental matters that affect your business. Essentially all aspects of your business and the environment you operate in which could lead to potential gains and losses in the future.

As a seller you could also demand due diligence on the prospective buyer of your business, in which his reputation, his ability to pay the transaction price, etc., could be investigated.

I always advise a seller to engage his own seller’s due diligence before the start of negotiations with prospective buyers. It is better to know your weaknesses and solve them in advance. This will help you gain a stronger position during the negotiations, and generally results in a higher transaction price.

 

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?

Walter: A buy-sell agreement, which is defined by Wikipedia as “a legally binding agreement between co-owners of a business that governs the situation if a co-owner dies or is otherwise forced to leave the business, or chooses to leave the business,” is especially important when a closely held business is owned by a limited number of owners, normally two or three, with equal amounts of shares and voting rights. In such a situation, I generally advise to have a buy-sell agreement in place. It stipulates in details how the shareholders (or the heirs in case of a deceased owner) will have to act if one of the owners (or heir) wants or needs to sell and the remaining owner(s) want to buy the shares. If such an agreement is drafted in a situation of stability and peace, there is less risk of anxiety and problems in case of instability. For instance when the owners have a serious dispute among themselves or in case of death of one of the owners.

 

Tina: I am located in the United States and I am selling my online business. I have a few international clients and employees. One of my international employees is interested in buying the business. We both plan to have the business appraised. Will there be a significant difference in the appraisal?

Walter: If both engage their own appraiser, this could happen. It depends on the standards being used, the appraisers being engaged, the information both appraisers have available, the quality of the industry analysis they do, etc. This risk could be minimized if both appraisers have the same information available and if parties agree about the standards to be used in the valuations. Parties could also consider to c0-engage an independent appraiser who advises both seller and prospective buyer about the value of the company. Based on that valuation, parties could derive the eventual transaction price. The question you should ask yourself is at what price you would be content in selling your business. Later you could benchmark the independent valuation against your initial expectations.

 

Tina: What are some issues that may come up when selling my business to an international buyer?

Walter: In general, an international transaction is more complicated, since there are more and different legal, tax and cultural issues to be dealt with. Sometimes language differences could result in additional complications as well.

However, in past decades, more and more cross-border transactions have taken place. Hiring the right advisers who have experience in executing international transactions, could significantly help to avoid and reduce these differences and resulting risks. 

 

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

Walter: Always do your homework seriously and understand the implications of the transaction at stake. Take your time to study and analyze the economy, the industry and the business itself. Hire the best advisers like business appraisers, lawyers, due diligence and tax advisers etc. The transaction costs incurred will be earned back easily by:

  • avoidance of common mistakes
  • paying the right price and,
  • having a solid contract in place to protect you at the time of the transaction and in the future.

Business Valuation From the Appraiser's Perspective

Key Points from our Conversation

  • Most buyers perform a business valuation prior to engaging in an M&A transaction.
  • Free cash flow represents the main value driver of any business no matter what industry they are in.
  • It is largely understood that most of the value in successful companies lies in the intangible assets.
  • The first aspect any buyer or investor considers when buying a business is the cash it generates and returns to the buyer.

Interview

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

Marcus: Performing a business valuation prior to selling your business is always recommended.  Whether your company is a large private corporation or a small family business, knowing the fair market value allows you to identify what are the key value drivers, make strategic decisions that maximize value and mitigate potential risks. In fact, I always advice clients to conduct a business valuation at least once a year as part of a strategic plan, set goals and work towards increasing the enterprise value over time.  Once you have had time to optimize the value drivers of your business, it is recommended you start preparation at least 3 months early so that potential issues that may arise during the transaction are addressed prior conducting due diligence.  This not only increases the chances of selling the business faster, but it also may increase the investment value perceived by the buyer.              

 

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

Marcus: There are different ways of getting a premium value for your business. Although it may vary depending on the type of industry, market and macroeconomic environment the business operates in, most buyers usually pay a premium when they see investment value as a result of the following:

  • The business is scalable and well diversified in its product line.
  • The business has consistently generated attractive margins and healthy, steady cash flow.
  • There are potential synergies to be achieved in the event of a merger/sale which considerably increases the investment value.
  • There are significant barriers to entry and limited competition.
  • Management is composed of skilled, experienced and committed professionals. 
  • The business has a solid revenue model with recurring revenues.
  • The business has presence in key markets with strong growth forecasts.

Buying a business is a significant investment decision for most buyers.

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

Marcus: In my opinion, the three most critical factors that improve the value of a business is the ability to generate free cash flow, the cost of capital and the business intangibles. Free cash flow represents the main value driver of any business no matter what industry it is in.  The first aspect that any buyer or investor considers when buying a business is the cash it generates and returns to the buyer.  Secondly, the cost of capital represents the required rate of return any investor would ask when investing in a similar business. As the business uses its capital more effectively and achieves an adequate capital structure, the cost of capital decreases and as a result, the enterprise value increases.  And third, businesses in a growing industry with proprietary technology or intellectual property enjoy a differentiation factor with respect to competitors which makes the investment attractive and appealing for the potential buyer.    

 

Tina: From a valuation perspective, why and how is every business unique?

Marcus: Each business operates within a unique macroeconomic environment under its own financial set of circumstances that affect the way its people manage the business and market its products and services, competing in an industry with its own set of regulations selling to clients in different markets.  As a result, to adequately value a business there must be a thorough understanding of every aspect of it, including its financial situation, competitive advantages, value proposition, product offering and macroeconomic environment, among other things. From a valuation standpoint, each business is different in that it has its own strengths, weaknesses, opportunities and threats and competes under different scenarios which may eventually impact the enterprise value.     

By starting early with due diligence, it will help the owner identify critical issues that can force the buyer to lower the offer or even walk away from the deal.

Tina: Do buyers of businesses place any weight on a business appraisal?

Marcus: Indeed, and based on my experience, most buyers perform a business valuation prior to engaging in an M&A transaction. Since buyers are probably not familiar with the target, it is always recommended that a certified valuation professional conducts a thorough assessment of the business to identify and understand the key value drivers in an effort to mitigate potential risks.  Thus, it allows the buyer to have a credible opinion and objective review of the subject company to ensure the investment is appropriate and meets the buyer’s expectations.  So, although the buyer is ultimately the one who decides whether to invest in the business and how much risk he/she is willing to assume, a business valuation guides the buyer towards understating the fair market value and making the right decision.  

 

Tina: I am thinking about buying a business. Should I consider a valuation, or at least some advanced due diligence, for the company that I am considering purchasing?

Marcus: Buying a business is a significant investment decision for most buyers. So it is always a good idea to conduct an adequate assessment to ensure the investment meets your expectations and that no unwanted surprises arise after the deal is closed. At least, we recommend conducting a valuation analysis and performing enough due diligence to ensure that the most critical factors relevant to the business such as financial, operational and legal, are all sound and squared away.  The potential risks and consequences of making a bad investment, especially in these days, are just too high compared to the cost of engaging a business valuation professional and M&A advisor.   

I always recommend business owners to perform a valuation at least once a year to work on key strategies that can add value to the business.

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

Marcus: There is business software available online that can be helpful however, it definitively has its limitations.  The hands-on approach of a valuation expert when conducting the appraisal such as meeting with key management and employees on-site, visiting the facilities, meeting with suppliers, checking out competitors and networking with industry professionals is extremely helpful towards selecting the right methodology and making adequate assumptions which are immensely important.  It is largely understood that most of the value in successful companies lies in the intangible assets; therefore the business judgment of the valuation expert plays a key role and is of significant importance when making adequate assumptions and conclusions of value. Since valuation is more art than science, I believe that no business software can ever substitute the work of an expert.         

 

Tina: Can you appraise my business if it is located outside of the United States?

Marcus: Although business valuations are not limited to the United States only, it is critical that financial statements comply with the Generally Accepted Accounting Principles (GAAP) established by the American Institute of Certified Public Accountants (AICPA).  This is done to ensure financial statements meet AICPA’s standards and are consistent when used for business valuation purposes. We have performed several business valuations for non-US companies and we recommend having financial statements adjusted to GAAP standards so that values are in range with industry peers.  That way we are capable of analyzing the business and giving an opinion of value which is consistent under US valuation standards and guidelines.  

When valuing intellectual property, it is necessary to estimate the incremental earnings that the intangible asset can create for the buyer.

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

Marcus: Usually it is recommended to have intellectual property valued separately as long as it can be considered a stand-alone asset with revenue-generating capabilities and not entirely dependable on the enterprise. Normally, IP valuations are driven by the earnings capability of the intangible asset and are based on the projected royalties which can be generated. So, when valuing intellectual property, it is necessary to estimate the incremental earnings that the intangible asset can create for the buyer.  As a result, it is recommended to have a certified valuation analyst or business appraiser with extensive intellectual property knowledge and experience to calculate the fair market value of the intangible asset on a stand-alone basis.

 

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

Marcus: As part of their strategic plan, I always recommend business owners to perform a valuation at least once a year to work on key strategies that can add the value to the business. Knowing the enterprise value can help you identify the main value drivers that can contribute to better manage the business going forward.  You should not wait to have an offer from an interested buyer to perform a business valuation because the owner may lose upside potential that cannot be capitalized since there is not enough time to optimize value.  Also, if the owner is interested in selling the business, engage a valuation/M&A advisor work with him/her on developing an exit plan to adequately address business as well as personal factors that are critical to prepare for the deal.  By starting early with due diligence, it will help the owner identify critical issues that can force the buyer to lower the offer or even walk away from the deal.

 

Necessary Steps When Selling Your Business

Key Points from our Conversation

  • Just like consumers will spend more with a credit card, business buyers may pay more when seller or bank financing is involved.
  • There should be an exit plan from day 1, but the tactical and implementation of it normally takes place a few years before the sale.
  • The expert can also guide the buyer in their negotiations, initial and counter offers and proposed deal structure.
  • My experience has been that “another set of eyes” usually reveals something (hopefully positive) that may have been missed.

Interview

Tina: I am a buyer, how do I know if I am paying too little or too much for a business? How can I protect myself from paying too much?

Michael: There are many factors that go into what a buyer pays, and conversely, what a seller accepts for a business. For example, the motivations of the buyer and seller, as well as the negotiating strength of each party are crucial factors. Are there other buyers making offers? How badly does the seller want to exit the business? Is the seller in need of cash or is he/she in financial distress? Is there a health issuer requiring the seller to move quickly?  Is there seller (or other) financing? Just like consumers will spend more with a credit card, business buyers may pay more when seller or bank financing is involved.

It is crucial that a buyer has an expert to guide him. A valuation professional can give you an opinion of value based on what comparable businesses have sold for and by using other accepted valuation procedures. The expert can also guide the buyer in their negotiations, initial and counter offers and proposed deal structure. As an example, I recently advised a client looking to buy a parts reseller. Before I got involved, my client wanted to start at $175,000. I cautioned him that the company only had 2 years’ history and had been in the hands of the current owner for only a few months.

In addition, I advised my client that the seller’s financial presentation was biased towards the seller (i.e., inflated adjustments). In the end, my client’s 2nd offer was for $160,000, and the discussions ended there, as the seller wanted much more and my client did not see much value beyond $180,000. He saved himself tens of thousands of dollars by having professional advice. In conclusion, it is part art and part science as to what is the “right price.” You will get a return many times over the fee that you pay an advisor to help you navigate through the process.

Most businesses with more than one shareholder should have a buy-sell agreement and all businesses should have a continuity plan in the event of the death or incapacitation of the main owner/shareholder.

Tina: If I also own the real estate, is it necessary to have my business and real estate appraised separately?

Michael: Yes, the real estate is typically a separate transaction. If bank or other financing is involved, the lender will require an appraisal. This approach will also give clarity as to what you are paying for the business, since the price will not be bundled with the real estate transaction. In many cases, the Real Estate may be legally required (e.g., FHA/ government regulations, state law, etc.) to be a separate transaction.

Fair market value is more hypothetical, whereas, strategic value is typically much higher since it considers value to a specific buyer.

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.

Michael: I currently have a client that is an internet developmental stage company and am well suited to answer this question. There are a number of factors that go into the valuation of a startup: is there anything proprietary about the web or software development? Is there a plan to monetize the site or create a revenue stream? How realistic is the plan? To answer this specific question, the value is going to be centered around (a) what would it cost to build or replicate the site? (b) has any of the web development been capitalized (i.e., shown on the balance sheet as an asset)? And (c) what is the value of the domain name? When is the company projected to become profitable? Has managed explained how those projections can be achieved in the time frame given?

Typically when discussing value, we are referring to fair market           value (see definition below). We need to keep in mind the difference between fair market value vs. strategic value. Fair market value is more hypothetical, whereas, strategic value is typically much higher since it considers value to a specific buyer. For example, we may see Google or Facebook, or Apple purchase a technology or company with no revenue for billions because it has that value to them and their strategy.

The International Glossary of Business Valuation Terms, issued by the American Institute of Certified Public Accountants (AICPA), the American Society of Appraisers, the Canadian Institute of Chartered Business Valuators, the National Association of Certified Valuators And Analysts and the Institute of Business Appraisers, defines fair market value as: “The price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.”

A minority interest will usually “trade at a discount” compared to a majority interest.

Tina: In many lower middle-market businesses, investment bankers to 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)?

Michael: As a valuation professional (Certified Valuation Analyst via the National Association of Certified valuators And Analysts, NACVA.com), I admit I am biased towards having a valuation. My experience has been that “another set of eyes” usually reveals something (hopefully positive) that may have been missed. The reward of finding “extra value” pays for itself many times over vs. the cost of a professional opinion. A valuation may also lead you to consider other factors that you may not have, for example, the economy (regional or local) or the industry trend, both of which impact value.

A buyer that does not have control or cannot influence operations, usually would not be willing to pay as much as they would for a majority stake.

Tina: Is a business appraisal for a minority interest different than for that of an entire business?

Michael: A minority interest will usually “trade at a discount” compared to a majority interest. The reason is that a minority owner typically has less influence and control over the operations and the ability to influence profits. The same holds true from a buyer’s perspective. A buyer that does not have control or cannot influence operations, usually would not be willing to pay as much as they would for a majority stake. There are exceptions. For example, let’s say there are three equal shareholder’s at 33.3% each. If a 33.3% minority interest were sold to a buyer aligned with one of the other two shareholders, than that 33.3% stake could be viewed as “swing vote or share” and command more value than otherwise expected with a minority stake.

If a death is involved, the surviving spouse will have his/her hands full, and having an updated value for the business will protect all who are involved and make the transition (buyout) much smoother.

Tina: If I am thinking about exiting my business, what are my options and when should I start planning for this?

Michael:  Exit planning is very important. To use an illustration, it is like staging a house for sale. You want to give the best appearance and show the value of your asset. A good planning process takes three to five years. This includes maximizing profits, making sure the operation is lean, but has a “platform for growth,” and that all key skill sets are filled in (i.e., depth of management). Other facets of exit planning include tax considerations and communications/public relations. In essence, there should be an exit plan from Day 1, but the tactical and implementation of it normally takes place a few years before the sale.

 

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?

Michael: This is crucial. I recommend that the business value be updated annually. Once the initial valuation is complete, future, successive valuation updates should be less costly and involved. The benefit to annual valuations is that, in the event that there is a death or resignation, or other event in which a shareholder leaves, the business will most likely be interrupted. If a death is involved, the surviving spouse will have his/her hands full, and having an updated value for the business will protect all who are involved and make the transition (buyout) much smoother.

A buy-sell agreement makes sense, not just for the business, but it also will give comfort and assurances to creditors, bankers and even key personnel or employees.

Tina: When does a business need a buy-sell agreement? Is this a common issue that you encounter? If so, what advice do you have for business owners?

Michael: Most businesses with more than one shareholder should have a buy-sell agreement and all businesses should have a continuity plan in the event of the death or incapacitation of the main owner/shareholder. It makes sense, not just for the business, but it also will give comfort and assurances to creditors, bankers and even key personnel or employees. My experience is that most businesses overlook this item. It should be part of every business’s strategic and financial planning. Be sure to consult your attorney.

 

Tina: Is there a right or wrong time to have my business appraised?

Michael: Business valuations are usually driven by needs: planning purposes, the sale of the business, tax purposes, etc. So there is no “right or wrong time” per se; a business valuation should be done when a need arises. Always seek a qualified, credentialed business valuator.

Audited financial statements are not crucial to the small business owner. Most small businesses are not complex and buyers will rely on federal tax returns

Tina:  Should I have my financial statements audited if I am thinking about selling my business?

Michael: Audited financial statements are not crucial to the small business owner. Most small businesses are not complex and buyers will rely on federal tax returns. For a larger or more complex business, a review or audit may be beneficial. Tailor the services to the situation and need by consulting with your CPA and transaction advisor.

 

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

Michael: Buying and selling a business is a multi-month, and in some cases, a multi-year process. There are a lot of disciplines and skills needed: legal, financial, tax, regulatory, etc. Make sure you have a competent and trusted advisor. If a broker is involved, make sure you understand whether he/she has a contract and or fiduciary responsibility to one of the parties. Typically the business broker represents the seller. If you are a buyer, I highly recommend engaging your own representative. Sometimes the law dictates the parties’ relationship and responsibilities; for example, Florida law requires business brokers to be truly neutral, and the transaction broker is a true “middle man” and does not represent either party. For business valuations, credentials are important, but not the only criterion. Does the valuator have good business acumen? Have they worked in businesses or corporations (i.e., client side)? Is their entire career as a valuation practitioner? Have they owned a business? Do not be afraid to ask questions or ask for references. Don’t miss the obvious such as googling a firm or person.

Key Points from our Conversation

  • 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.
  • 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.
  • 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.
  • 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.

Interview

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:

  • Sale to a third party
  • Sale to employees, including an ESOP
  • Sale or gift to family members
  • Sale or gift to a trust
  • Liquidation of assets

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:

  • Credentials, does the appraiser hold certifications that are generally recognized as credible and are those credentials relevant to the valuation.
  • Experience, how long has the appraiser been appraising businesses, how many valuations has the appraiser performed, has the appraiser performed valuations of companies with similar operations as mine, does the appraiser have expert testimony experience;
  • References/Credibility, a good appraiser should be able to offer you references and or sample reports to illustrate the level of due diligence the appraiser performs. A good appraiser also needs to be able to deliver an independent work product, similar to an auditor and appraiser has standards that need to be meet to ensure an ethical, independent work product;
  • Timeline, depending upon the purposes of the valuation the time it takes to complete the engagement may vary slightly, however don’t be afraid to ask what the expected timeline for completion is and question the process if the proposed timeline seems outlandish. I would say most quality appraisals can be completed within 4 to 6 weeks from the time the financial information is received by the appraiser; and
  • Pricing, based upon my direct experience working for several different firms, as well as seeing fees charged by other valuation professionals it is sad to that you do not always “get what you pay for.” I recently reviewed a valuation in which the firm charged $120,000 for a project that I felt was lacking sufficient due diligence, and yet I have seen valuations which cost $10,000 that were very thorough and would hold up in a court of law.

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:

  • Have the business appraised by a qualified, independent appraiser;
  • Talk with your accountant, financial advisor, and attorney and maintain their involvement throughout the process; and
  • Make sure you are comfortable with the transaction; there is no such thing as a dumb question!

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.

 

Key Points from our Conversation

  • Even if you are not considering selling your business at this time, having your business appraised to understand its fair market value is a good idea.
  • Well-written, comprehensive business valuation reports should tell a story that allows a reader to read the report from start to finish and understand the appraiser’s rationale and thought process in determining their opinion of value.
  • The three primary approaches to valuing any closely-held business are an asset-based approach, an income-based approach, and a market-based approach, and within these approaches are multiple valuation methods which can be utilized to estimate the value of a business. 
  • The most important advice that I give to business owners looking to have their business appraised is to be sure to use an accredited valuation specialist. 

Interview

Tina: A company/individual has approached me and wants to buy my business. I am not considering selling my business at this time. Should I have my business appraised?

John: Even if you are not considering selling your business at this time, having your business appraised to understand its fair market value is a good idea.  Independent studies have shown that a business owner’s estimate of the fair market value of their business often varies by 50% or more when compared to a subsequent appraisal.  For most business owners, their business represents their single largest asset and is a key piece in their overall retirement plan.  Thus, a business owner’s misconception about the value of their business could result in sabotaging their overall financial and retirement planning. 

In addition, a business owner receives significant additional benefits from a business appraisal other than just learning its value.  One of these benefits is obtaining a better understanding of how the business compares to its peers financially through a comparison to industry averages.  This financial analysis and comparison to its peers can identify not only company strengths, but also inefficiencies and weaknesses that are negatively impacting business value.  At my firm, we regularly consult with our clients about the weaknesses and threats facing their business. We help identify ways to correct these weaknesses and mitigate the threats to help increase business value. Furthermore, business owners can learn what the real “value drivers” are for their business, and a business appraisal can be used as a tool to help actively manage and grow their businesses value.

Independent studies have shown that a business owner’s estimate of the fair market value of their business often varies by 50% or more when compared to a subsequent appraisal.

Tina: What documents do you need from me to appraise my business?

A:  Typical documents needed to appraise a business include the following:

  • Federal income tax returns for the business for the 5 most recent fiscal years
  • Financial statements for the business for the 5 most recent fiscal years and the most recent interim period available in the current fiscal year (preferably compiled, reviewed or audited by an accountant, but if that is not available then internal financials from QuickBooks can be used)
  • Copies of any company budgets or financial forecasts for any current or future years (if any are available)
  • Copies of any organization documents for the business (articles of incorporation, by-laws, shareholder agreements, or other buy-sell agreements).  Additional documents beyond these basic documents will vary from business to business based on the type of business and the facts and circumstances surrounding the appraisal.

TinaWhat is the "finished product" when a valuation engagement or calculation engagement is performed? How long is the report? Will I be able to understand it?

A: What different types of business appraisals are called and the type of reporting they include varies from firm to firm. They vary because firms have different accrediting agencies, and the standards accrediting agencies hold their members to also vary. However, the more basic type of business valuation is typically referred to by most business appraisal firms as a calculation engagement or an estimate of value.  In this type of engagement, the appraiser is not providing their opinion as to the fair market value of the business, but instead is providing an estimate of the fair market value of the business using generally accepted valuation methodologies.  The finished product for a calculation engagement or estimate of value often consists of an abbreviated two to five page report attached to approximately 10-15 pages of valuation schedules. These pages summarize the historical financial performance of the business and the various valuation methodologies used to estimate the value of the business. 

The more complex type of business valuation is typically referred to as a comprehensive business valuation report or valuation engagement.  In this type of engagement, the appraiser performs the substantive procedures necessary to render her opinion as to the fair market value of the business.  The finished product is a very detailed report that summarizes the interest being appraised, the purpose of the appraisal, the standard of value utilized in the report, an analysis of economic and industry forces that are currently impacting the business, a summary of the history and operations of the business, a detailed assessment of the businesses’ historical financial performance, a complete discussion of the various valuation methodologies used and any relevant valuation discounts that may be applicable to the interest being appraised, and a reconciliation of value of the various valuation methods.  Most comprehensive business valuation reports are in adherence with the Uniform Standards of Professional Appraisal Practice (“USPAP”), which is important for appraisals that need to be in compliance with the “Qualified Appraisal” standards of the Internal Revenue Service. These reports range from 60-100 pages in length. 

Well-written, comprehensive business valuation reports should tell a story that allows a reader to read the report from start to finish and understand the appraiser’s rationale and thought process in determining their opinion of value. Thus, in general, comprehensive business valuation reports are easier to understand than calculation engagements, as the brevity of the calculation engagement report does not provide enough information to the reader to understand the appraiser’s thought process and rationale or provide adequate explanation of the valuation methods utilized.

 

Tina: What can I do if I am not happy with the appraisal I receive from my business appraiser?

A:  The first step I always suggest to any business owner is to meet with the business appraiser and have the appraiser walk through the entire valuation report with them.  This exercise is invaluable as it helps the business owner to have a complete understanding of the thought process and rationale as to how the business appraiser determined the value of their business.  If the business owner is still not happy with the appraisal, a second business appraiser can be engaged to either prepare an entirely new appraisal or to review the first appraisal for its reasonableness, accuracy and adherence to generally accepted valuation methodologies and relevant valuation standards. 

The first step I always suggest to any business owner is to meet with the business appraiser and have the appraiser walk through the entire valuation report with them. 

Tina: Do I need to sell my entire business? What are my options? Do I need an appraisal if I only sell a portion of my business?

A: No, you do not have to sell your entire business.  A buyer can purchase either an entire business or a specified percentage of a business.  When selling to third parties, it is generally easiest to sell an entire business, as most individuals buying a business want to have complete control of that business.  However, fractional interests of a business can also be sold.  We typically find that sales of fractional interests most often occur when a business owner is selling to either:

  • (a key employee (or employees)
  • an employee stock ownership plan (ESOP), or
  • other members of the owner’s family

Fractional interest appraisals often require a business valuation so that the business owner can comply with various tax regulations established by the Internal Revenue Service (IRS).  For example, when a business owner sells a fractional interest in their business to a son or daughter, a business appraisal must be prepared to substantiate to the IRS that the price paid for the fractional interest was equivalent to fair market value and that no implied gift has occurred.

 

Tina: I would like to keep the sale of my business confidential. I worry that my CFO will become suspicious if I start requesting a bunch of financial documents for the appraisal. How can I keep the sale confidential, and who should be informed about the sale of my business?  

A:  We often have business owners who worry about confidentiality and do not want employees, vendors, and certain other people finding out about the possible sale of the business.  Businesses are appraised for a multitude of reasons, and the business owner does not need to inform anyone about the sale until he/she believes it is the right time to do so.  In addition, in the above example, if the business owner believes that the CFO is becoming suspicious, the business owner can inform the CFO that a business appraisal is being prepared for insurance purposes or for general estate planning purposes for the owner.  This statement usually alleviates the concern or suspicion of the employees.  Furthermore, when business owners are working with a broker or an attorney on the sale of their business, the broker or attorney can provide valuable advice as to the timing of any announcement regarding a business sale to employees, vendors, customers, and others.

Businesses are appraised for a multitude of reasons, and the business owner does not need to inform anyone about the sale until he/she believes it is the right time to do so.

Tina: What is a common practice for dealing with accounts receivable and payable when selling a business?

A: When a business sale is structured as a stock sale, the buyer acquires all of the businesses’ assets and assumes all liabilities.  However, when a business sale is structured as an asset sale, the buyer acquires only selected assets (and may assume certain liabilities) of a business and places these assets and liabilities in a newly created entity.  From my experiences, the most common asset sale consists of a buyer acquiring inventory, fixed assets, and goodwill and other intangible assets, with accounts receivable and accounts payable being excluded from the sale.  However, if accounts receivable are being included in the asset sale, we typically also see accounts payable being assumed by the buyer.

 

Tina: What is the most common method for appraising businesses with less than $1 million in annual revenue? For $1-10 million in annual revenue? For $50 million or more in revenue?

A: This seemingly easy question has a complex answer, as size is not the only factor that guides the appraiser in determining which methods are most appropriate to utilize.  The three primary approaches to valuing any closely-held business are an asset-based approach, an income-based approach, and a market-based approach, and within these approaches are multiple valuation methods which can be utilized to estimate the value of a business.  The methods selected to value a business vary based on several factors, including, but not limited to, size, type of business, and the percentage of the business being appraised.

Valuation methodologies such as the guideline public company method (which is a market-based approach that compares a business to comparable businesses that are publicly-traded) are generally not used when valuing smaller businesses because of the significant differences in size and operating characteristics between smaller businesses and their publicly-traded counterparts. When valuing a controlling interest, asset based valuation approaches may be applicable, but they are not generally viewed to be applicable when valuing a non-controlling fractional interest in a company.  Furthermore, a method for which its applicability varies from industry to industry is the comparable transaction method (which is a market-based approach).  This method computes pricing multiples (typically either a revenue multiple or some measure of profitability) from actual sales of businesses similar to the business being valued that are reported in proprietary transaction databases subscribed to by appraisers.  Thus, the ability of an appraiser to utilize this method depends on the quantity and quality of the transaction data for the specific business being appraised.

The methods selected to value a business vary based on several factors, including, but not limited to, size, type of business, and the percentage of the business being appraised.

Tina: Do you recommend business owners look for accredited valuation specialists? If so, what are the different designations and what are the differences in the different designations?

A: The most important advice that I give to business owners looking to have their business appraised is to be sure to use an accredited valuation specialist.  The most common business valuation designations held by business appraisers are:

  1. Accredited Senior Appraiser (ASA) offered by the American Society of Appraisers;
  2. Master Certified Business Appraiser (MCBA) or Certified Business Appraiser (CBA) offered by the Institute of Business Appraisers;
  3. Accredited in Business Valuation (ABV) offered by the American Institute of Certified Public Accountants; and
  4. Certified Valuation Analyst (CVA) offered by the National Association of Certified Valuation Analysts. 

Furthermore, it is important for business owners to note the significant differences in the requirements to attain each designation, with the differences being in the areas of experience requirements, educational training and testing, and peer review of an actual appraisal report.  It is widely known throughout the profession that the ASA designation is the most rigorous designation for appraisers to attain as its requirements consist of passing a 15-hour Uniform Standards of Professional Appraisal Practice (USPAP) course, passing an ethics exam, passing four 32-hour classes known as BV201, BV202, BV203 and BV204, having a 4-year college degree or equivalent, submitting an appraisal log proving a minimum of 5 years of full-time business valuation experience, and submitting one valuation report for peer review.  Thus, my advice to most business owners is the best way to make sure that you will be receiving a high-quality business appraisal report is to engage the services of an ASA business appraiser.

 

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

A:  A few tips for buyers interested in acquiring a business include the following:

  1. Do your due diligence prior to acquiring the business
  2. Hire a business appraiser to properly understand the fair market value of the business, as overpaying for the business at the beginning can sabotage future cash flows (if financed) and will reduce your overall return on investment
  3. Be sure to obtain proper legal representation and tax planning, as the proper structuring of an acquisition from a legal and tax standpoint can make a big difference for a buyer.

A few tips for owners interested in selling their business are to:

  1. Start your planning to sell your business a minimum of 2-3 years in advance, as proper planning for the sale of a business helps ensure that you will obtain the highest possible price for your business upon sale
  2. Utilize a business appraiser during the planning process to help identify the fair market value of the business at the beginning of the planning as well as learn the various weaknesses and shortcomings of the business that need to be remedied prior to listing the business for sale to help maximize its value
  3. Be sure to obtain proper legal representation and tax planning, as the proper structuring of a sale from a legal and tax standpoint can make a big difference in the “net proceeds” realized by the seller.  My firm regularly works with business owners during the “planning to sell” phase and the additional increase in the value of a business that can be achieved through proper planning is significant.

Improve the Value of Your Business and Sell It Faster

Key Points from our Conversation

  • Ultimately the only effective shortcut for a sales process is to plan far ahead for your desired liquidity timeline and work towards that goal with the aid of your trusted advisors by proactively implementing the best practices of a much larger organization into your business.
  • Formal appraisal or not, it is essential that you have reasonable expectations for the range of values your business may achieve in the marketplace along with an understanding of the key drivers of that value range.
  • There are four main types of funding for a new company: the initial investment comes from your personal funds as the owner or founder; the next level is often money from friends and family who believe in you; then come the angel investors who see potential in the “idea” of your business and provide money to help develop the business; and after that comes venture capital—funding often to expand the business.
  • In fact, an essential part of any deal is the preparation phase, which can take several months or longer.

Interview

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

Garrett: Effective management depth, attractive returns on invested capital and an optimized capital structure are key factors that can improve the value of any business. Potential buyers recognize that management depth greatly affects the vision, growth, stability and longevity of an enterprise. Additionally, buyers will often reward businesses within attractive industries that harness key differentiators from competitors with higher valuations due to their superior long-term returns on invested capital. Lastly, trusted advisors can assist management in unlocking tremendous business value through the strategic process—either in isolation or as part of the M&A process—of optimizing the capital structure. Ultimately, any business that proactively incorporates these three factors into its culture can significantly improve its value in the marketplace.

 

Tina: On average, how long can I expect for it to take to sell my business? Is there anything I can do to speed up the process? Any shortcuts I can take?

Garrett: If the goal is to maximize price—as it usually is—the sale process can sometimes take substantially longer than a business owner might expect. The sale process frequently requires six to nine months from the time an owner is fully prepared to sell his or her business to the ultimate closing of the deal, including buyer outreach efforts, the fielding of indications of interest, due diligence, the negotiation of final terms and documentation, and any pre- and post-closing adjustments. Although these specific steps are considered by many to be the sale process, they really constitute just the tip of the iceberg. In fact, an essential part of any deal is the preparation phase, which can take several months or longer and can have a material impact on the length of the sale process and outcome of the deal. Being thorough during the preparation phase—including engaging trusted advisors early in the process—can dramatically speed up the entire sales process and improve the outcome. This preparation phase involves simulating the due diligence that a potential buyer will ask of your business, including gathering critical and accurate financial, human resources, marketing, customer, supplier, environmental, regulatory and legal information. Ultimately, the only effective shortcut for a sales process is to plan far ahead for your desired liquidity timeline and work towards that goal with the aid of your trusted advisors by proactively implementing the best practices of a much larger organization into your business.

An essential part of any deal is the preparation phase, which can take several months or longer and can have a material impact on the length of the sale process and outcome of the deal.

Tina: I am preparing to sell my business. Do you feel it is necessary for every business to receive a formal business appraisal prior to being listed for sale? Would there be a time a business appraisal would not be necessary? 

Garrett: While a formal business appraisal may be beneficial in many ways, not every business needs to pay for one prior to going to market. In the absence of a formal appraisal, however, you may risk being misinformed about the value that your business can achieve in a sale. Formal appraisal or not, it is essential that you have reasonable expectations for the range of values your business may achieve in the marketplace, along with an understanding of the key drivers of that value range. By understanding this before formally placing your business for sale, you help to ensure that you are not diverting your valuable time and effort towards a sale process that has little to no chance of achieving the outcome you desire. Ultimately, the capital market sets the value for your business so having timely and relevant information about that market is key to making the right decision for you and your business. This usually involves the help of an appraiser and/or a trusted advisor.

 

Tina: The buyer submitted an offer contingent on bank financing. Is he going to need a business appraisal? Will I be required to provide financing if the bank does not give financing?

Garrett: No, a bank does not typically require an appraisal. The bank providing the financing is primarily interested in the collateral and/or cash flow of the business—saleable assets available should the borrower default on the loan. In some situations, the bank may request an appraisal, but it is the exception and not the rule. If the bank does not approve the financing, the seller is not required to provide financing unless it has already been formally agreed to in a definitive executed document. Ultimately, the seller is not required to sell the business to that buyer. So, at that point a decision must be made to either proceed with seller financing for that buyer, with an understanding of the inherent risks involved, or to move on to other potential buyers. If a seller provides financing, he or she should perform serious due diligence regarding the counterparty and performance risk of receiving future payments under the deal terms. The seller will need to decide if he or she is willing to sell the business for the down payment and risk receiving nothing else in the future under a worst case scenario. While seller financing is normal in some industries, there is always a substantial risk.

If a seller provides financing, he or she should perform serious due diligence regarding the counterparty and performance risk of receiving future payments under the deal terms.

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

Garrett: A normalized salary is the economic value of somebody’s time. This is determined by looking at what base salary, bonuses and benefits the employee (owner or otherwise) would earn for the time contributed in an arms-length open market. The arms-length nature of normalized compensation is key to understand, since many owners do not always take one but rather receive some combination of salary and distribution of profits. In determining the value of a business, the buyer will look at normalized cash flow—what the future cash flow of the company will be with normalized compensation for all employees including any owners who are active in the business. If the seller is taking more than the normalized compensation, they have effectively lowered the reported cash flows of the business that would be available to the buyer. If the owner takes lower compensation salary opting instead for profit distributions, he or she has indirectly inflated the reported cash flow that is available to the buyer. These numbers need to be adjusted to normalized numbers so the buyer understands the amount of future cash flows that they are purchasing.

 

Tina: Should I sell my business to a foreign acquirer? What are the risks/benefits, if any?

Garrett: There is no reason to constrain your pool of potential buyers. When selecting a buyer, it is important to clearly examine the risks and benefits of the sale to you and your organization. If the foreign acquirer is the best potential buyer for your business, then sell to that person or entity. For example, the purchase of an existing US business can be an easy way for a foreign acquirer to enter the market and they will often pay more for the opportunity than a domestic buyer might. Some of the risks of selling to a foreign acquirer may include more complicated litigation in a deal dispute or cultural issues during integration. For some businesses and industries there may also be governmental regulation issues that may impede, prevent or delay a sale to a foreign acquirer.

Some of the risks of selling to a foreign acquirer may include more complicated litigation in a deal dispute or cultural issues during integration.

Tina: What is an angel investor and should I sell my business to an angel investor? Are there risks/benefits to doing this?

Garrett: Different from venture capital or private equity investors, an angel investor is an individual who personally believes in the business idea and is willing to provide funding for a high return on their investment. They are generally an investor, not a buyer, and get involved early in your business development to see exponential returns later. There are four main types of funding for a new company: the initial investment comes from your personal funds as the owner or founder; the next level is often money from friends and family who believe in you; then come the angel investors who see potential in the “idea” of your business and provide money to help develop the business; and after that comes venture capital—funding often to expand the business. The availability of angel investors varies with the status of the company. The benefits include the fact that angel investors help build, sustain and grow your company, without needing full control of the business. As with any partnership, the risks are that you dilute your ownership too soon or disagreements with your angel partners arise.

 

Tina: What is an earnout and how can I structure an earnout to make sure I am paid?

Garrett: An earnout represents additional money paid to the seller based on the business’ future profits. It is designed to incentivize the seller to continue operating the business and remain engaged in the required management transition process in exchange for a higher total sales price. An earnout agreement can help bridge any divide in the opinion of the business’ value between the seller and buyer, by lowering the buyer’s risk and increasing the seller’s total net proceeds. One key to remember is that an earnout is never guaranteed. As such, it is essential that the earnout agreement be specific, concrete and measurable while containing predetermined dispute resolutions that may involve an independent consultant or mediator. Although more variables in the equation can help the buyer and seller get a deal done, they can also lead to more disagreement, more chance of litigation and more chance of not getting paid.

One key to remember is that an earnout is never guaranteed.

Tina: What is a Working Capital Adjustment? As a buyer, how will this affect the price of the business?

Garrett: Working capital is the amount of money that is necessary to operate the company effectively. These funds allow businesses to pay for normal ongoing costs when they are incurred while they are waiting to receive ongoing revenues. A discussion of working capital in the context of a sale centers on three key numbers: baseline working capital, actual working capital and a working capital adjustment. When selling a business, you negotiate based on a snapshot of the company at a particular moment in time. This is the baseline—values assessed at a given time. When the sale closes later, the actual amount of working capital at the close is measured and may vary from the baseline working capital recorded. Part of the closing negotiations and settlement is to calculate the Working Capital Adjustment—the difference between the baseline and actual. The Working Capital Adjustment is then reflected as an increase or decrease in the final sales price. For example, if the baseline working capital was judged to be $5 million but was actually $6 million on the date sale the sale closed, the purchase price will increase by $1 million. If the actual was $4 million, the purchase price will decrease by $1 million.

 

Tina: How involved should my attorney be in the process of having my business appraised? Is it necessary to let them know I am appraising my business?

Garrett: The question is not necessarily should your attorney be involved, but who is your trusted advisor? There are a number of advisors who will be involved in the sale of a business – each with their own role. For example, you will likely need a corporate attorney to help prepare the company for sale, a transactional attorney to negotiate and contract the sale, a CPA to maintain and prepare the company’s books, a financial advisor or investment banker to coordinate the sale, and a few other advisors along the way. One of these advisors will be the central focus of the process and negotiations, including the potential valuation of the company. But at the end of the day, you need your financial advisor or investment banker involved in the business appraisal process, not your attorney.

When the sale closes later, the actual amount of working capital at the close is measured and may vary from the baseline working capital recorded.

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

Garrett: There are a few tips I would share with those involved in buying or selling a business:

  • The rewards are the greatest for those that start their own business rather than buying someone else’s. By starting your own company, you take on all of the risk, but you can also reap much higher returns.
  • If you buy a company, your returns will be enhanced if you find a way to add value to that business to increase long-term profitability. Otherwise you are simply buying a job.
  • Do not chase trends. Certain types of businesses have become very popular lately but if you are opening when the business is already trendy, you are often getting in at the wrong time when costs are high and competition is fierce. You want to be ahead of the trend—first movers typically reap the most rewards.
  • Do your due diligence! Know what you are buying and know what the value drivers and risks are.
  • Be reasonable on value, be prepared when you are ready to sell and have the right advisors in place.

Appraisals are based on professional judgment. Find a reputable, objective appraiser or financial advisor that you can trust.

The Role of Strategic Planning in Building Business Value

Key Points from our Conversation

  • For potential sale purposes, I would recommend getting an initial valuation a couple of years before a planned exit.
  • Generally speaking, private equity groups tend to pay somewhat less for a company than strategic buyers.
  • The best way to get a premium value for your business in a sale is by marketing your business to many different potential buyers.
  • Giving potential buyers flexibility with regards to your ability to stay on with the business during the transition period will generally increase the value.

Interview

Tina: How will I know when it is a good time to get my business appraised? How do I find the right business appraiser?

Steven:  The timing of your business appraisal depends on your needs. For potential sales purposes, I would recommend getting an initial valuation a couple of years before a planned exit. A full business valuation report will generally highlight the strengths and weaknesses of your business, which will showcase areas that you may be able to modify to increase business value before an eventual sale.

Finding the right business valuation professional can be a daunting task. Referrals from trusted advisors are a good way to get some initial names of potential business appraisers. I highly recommend hiring an appraiser with certifications that require extensive experience in business valuation, as well as hiring an appraiser with experience in valuing other businesses that are similar to your business. In addition, interviewing several business appraisers will give you some comfort regarding individual capabilities and making sure you get a fair price for the service.

 

Tina: I am preparing to sell my business within the next year. Can the timing of when I get a valuation affect the "value" of my business?

Steven: The short answer is no. A valuation report for potential sales purposes does not need to be shared with potential buyers, and should not have an impact on the value of the overall business.  However, if you choose to share the results of the appraisal report with prospective buyers, this may positively or negatively influence their perception of the business and what it is worth. The longer answer is that expectations regarding a potential sale of a business may affect the valuation of non-controlling, non-marketable interests in the company’s stock. If you plan to sell your business within the next year, the value of a non-controlling, non-marketable interest will generally be higher than if there were no plans to sell the business.

The timing of your business appraisal depends on your needs.

Tina: Can I sell my business to a private equity group? Is this a smart decision? What are the risks/benefits of this?

Steven: The decision of what type of buyer to sell your company to is not an easy decision. There are pluses and minuses to selling to private equity groups, just as there are with strategic buyers. Generally speaking, private equity groups tend to pay somewhat less for a company than strategic buyers. This is the result of many strategic buyers being able to extract “synergies” from a combination of your business with their business. However, private equity buyers continue to have record levels of cash sitting on the sidelines, and they need to deploy that cash. These result in private equity buyers tending to be very competitive on price compared to strategic buyers.

Selling to a private equity buyer can be beneficial to you, depending on your needs. Some of the main benefits of selling to private equity buyers include the possibility of rollover equity, the possibility of continuing to manage the business and finding key partners to take your business to the next level.  Generally, strategic buyers want to purchase 100% of your business and may not take certain employees to achieve cost synergies. The primary downside of private equity buyers is that they tend to have less ability to pay top dollar relative to strategic buyers.

Business valuations consider the three valuation approaches: income, cost and market.

Tina: How do the appraisal approaches differ for appraising businesses vs. real estate?

Steven: Like real estate appraisals, business valuations consider the three valuation approaches: income, cost and market. Unlike many types of real estate, “comparable” business transactions tend to be limited in number, lacking information, or very dated. As a result, business appraisers tend to rely on an income approach as their main indicator of value. I would say that due to the reliance on projected cash flows, which can be extremely difficult to estimate, there tends to be more variation in values estimated for business appraisals than real estate appraisals.

 

Tina: How does an appraisal differ for the purposes of an ESOP vs. other types of appraisals?

Steven:  An Employee Stock Ownership Plan ("ESOP") appraisal will differ somewhat from other types of appraisals due to requirements under Section 3(18) of the Employee Retirement Income Security Act (“ERISA”) and the nature of the ESOP.  An ESOP creates liquidity for participants due to the put option of participants, which creates additional liquidity. While this reduces marketability issues with non-controlling ESOP shareholders, this obligation can create potential liquidity issues for the overall business. That being said, much of the valuation analysis for an ESOP appraisal is similar to other valuation analyses.

When selling your company, choosing to sell assets or stock has a direct impact on both the value of your business and the proceeds you receive.

Tina: Does structuring the sale as an asset or stock sale impact the valuation of my company?

Steven:  When selling your company, choosing to sell assets or stock has a direct impact on both the value of your business and the proceeds you receive. In general, an asset sale will result in the highest value of a business. This is due to the fact that the buyer will get a step-up in the basis of the assets to the sale price of the business, which will increase tax savings for the buyer. While this will generally net you the highest sale price for the business, this could result in less proceeds than a stock sale due to taxation on the sale of the business. In structuring the sale of your business, careful consideration should be given to whether a stock or asset sale would result in higher net proceeds.

Tina: Is there a practical difference between value and price, or is that just a theoretical discussion? How close to the final valuation figure can I expect to sell my business?

Steven: I think there is a lot of confusion regarding the definition of value and price. I like to think of price as a negotiated amount between two parties, and value as a result of calculations. In business valuations, value is typically defined as fair market value per IRS Revenue Ruling 59-60. The definition of fair market value can cause substantial differences from a “price,” but I would like to think that they are generally close to each other. The business appraisal conclusion can vary considerably from a sale price depending on multiple factors. Differences in the date of the appraisal and sale date, the type and amount of potential buyers and the definition of value used for the business valuation engagement can cause big differences. 

 

Tina: I am preparing to sell my business and I do not need a full appraisal. Can I hire a business appraiser to just offer me some guidance and help?

Steven:  Most business appraisers will offer services that do not include a full-blown appraisal. Many professionals will offer advice on an hourly basis to assist you with your business valuation needs. It is important to clearly explain questions to the business valuation professionals to make sure that fees are kept reasonable.

I highly recommend hiring an appraiser with certifications that require extensive experience in business valuation, as well as hiring an appraiser with experience in valuing businesses similar to your business.

Tina: Will I need to finance part of the purchase price of the business?

Steven: Virtually all business acquisitions will require buyers to provide some equity financing to consummate a business acquisition. The amount of financing will depend on several factors, such as the borrowing base of the assets acquired, the amount of seller financing and the payment terms of the purchase price. I would say that industries that have a significant amount of hard assets, such as manufacturing firms, tend to require much lower levels of equity financing, whereas technology companies tend to require significant amounts of equity financing.

 

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

Steven:  The best way to get a premium value for your business in a sale is by marketing your business to many different potential buyers.  An ideal situation would be to create a bidding war resulting in a purchase price for the business above its fair market value. The ability to get significant interest in your business will depend on many factors, such as the size and profitability of your business, growth trends, customer concentration, etc. To maximize the value of your business, I highly recommend retaining a highly qualified deal team. This would include, at a minimum, an investment banker, attorney and accountant.

Tina: I am willing to help with the transition long-term, possibly for up to one year. Will that help improve the value of my business?

Steven:  Giving potential buyer’s flexibility with regards to your ability to stay on with the business during the transition period will generally increase the value.  At worst, the buyers will thank you for the offer, and not increase the purchase price. The more instrumental you are in the operations of the business, the more buyers will pay. An example would be if you are the main contact on several key accounts. Buyers will pay less for a business if there is retention risk for key customers after you leave the business.

The more instrumental you are to the operations of the business, the more buyers will pay.

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

Steven:  My tip for buyers and sellers of a business is to read the purchase agreement carefully. I have run into issues where parties to a transaction were unclear or unaware of certain purchase agreement provisions that caused either pre or post deal issues.

Key Points from our Conversation

  • The transaction method becomes available as we gain insight into the pricing and terms of many early-stage venture capital-type transactions, allowing us to use them in our analysis.
  • A business needs a buy-sell agreement at the outset of the venture.   The longer you wait, the harder it will be to put in place.
  • It’s important to be thoughtful and thorough in the buy-sell agreement by thinking of as many contingencies as possible.
  • The expertise required to perform a business appraisal credibly takes years to acquire, and thus it is expensive to hire, train and retain staff with the skills, expertise and intelligence necessary to carry out the engagements.

Interview

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.

Michael: In the past, I have mainly used discounted cash flow models, relying on an anticipated exit value as the terminal value.  However, I find that I am increasingly relying on market-based methodologies as I have become more aware of reliable data being available and as I have improved my understanding of how the markets for such businesses operate.

For example, a number of emerging companies are publicly traded, which opens the door to the guideline public company method.  Looking at public markets for startup values is particularly fruitful in the biotech space.  You can find numerous pre-revenue companies in clinical trials that are traded as pink sheets, and there’s no obvious reason to think that those market prices are materially inaccurate in terms of value, particularly if the stock trades relatively frequently.

Further, we started using PitchBook a couple of years ago, and it contains a great deal of data regarding startup transactions and valuations.  Accordingly, the transaction method becomes available as we gain insight into the pricing and terms of many early-stage venture capital-type transactions, allowing us to use them in our analysis.

In addition to improving the robustness of our valuation analysis, these techniques also provide the client with useful intelligence as to how the market currently prices businesses such as theirs.

In rare cases, we will use real options modeling and simulation where the investment/return timeline is long and the company development process complex, such as in pharmaceutical research or aerospace.

 

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)?

Michael: An appraisal is almost never necessary to sell a business.  It’s also not necessary to appraise your home before selling it or to look up the Blue Book value of your car before selling it.  But few would argue that those aren’t good ideas.  For small business owners, that business likely represents most, if not all of their net worth—why would you not commission an appraisal before putting it on the market?

An appraisal is desirable for the following reasons: a) it empowers the sellers to manage the investment bankers—to know that when the banker is telling the seller that they have a good deal on the table, it actually is; b) the seller can avoid wasting time or being distracted by low-ball offers; c) the seller can avoid wasting time if their price expectations are unrealistic; and d) the seller can learn how to attract higher prices from bidders by changing certain things about their business. 

I work with many investment bankers who prefer to put a business on the market that we have appraised. It means that the seller has a realistic view of value, and the investment banker doesn’t have to spend time figuring out value (most vastly prefer to be in the market sealing the deal). Also, it sets a bar for incentive compensation (e.g. the banker gets a 10 percent performance bonus if they sell the business for 25 percent over the appraised value).

Investment bankers tend to follow the mantra that a business is worth what someone else is willing to pay for it.  I can easily counter this argument with a simple example: if someone is willing to pay $1 for your business, does that mean it’s worth $1, and you should sell?  Warren Buffet’s quote is more insightful: “Price is what you pay [or receive]—value is what you get [or sell].”

Investment bankers tend to follow the mantra that a business is worth what someone else is willing to pay for it. 

Tina: If I also own the real estate, is it necessary to have my business and real estate appraised separately?

Michael: Again, it’s not necessary to have business and real estate appraised separately, but it’s a good idea.  Real estate valuation and business valuation are separate disciplines, and few individuals are qualified to perform both.  Personally, I’m not even very good at Monopoly.  Real estate appraisals are generally so inexpensive relative to business appraisals that’s impossible to understand why you wouldn’t commission the real estate appraisal if you’ve already decided to proceed with the business appraisal.  It’s not terribly uncommon for the real estate to be the most valuable component of the business.  Accordingly, not having the real estate appraised leaves the client exposed to a significant blind spot relative to value.

 

Tina: If I am thinking about exiting my business, what are my options?

Michael: Your options for exiting a business may depend on the nature of the business itself as well as the owner’s personal circumstances:

  • If you have family members that could conceivably take over the business, the exit may, in fact, be a succession plan.
  • You may have a buy-sell agreement in place with business partners; simply execute the buy-sell agreement (if it’s written well enough and sufficient funds are available to execute feasibly).
  • You can put the business on the market. Chances are competitors, or potentially suppliers or customers, would have an interest in buying your business.  If the business is large and profitable enough, private equity buyers are always on the hunt for businesses.
  • Investment bankers can add value to the selling process.  They know how to make a market and create an auction for the business.  Unless you have very obvious buyers, most investment bankers easily earn their fees.
  • Employee stock ownership plans (ESOPs) are gaining increased attention of late.  They are expensive to implement and maintain, but they can generate the most attractive exits for owners in certain cases.  Setting up an ESOP involves selling all or part of the business’s stock into a trust. That trust is a pension instrument managed by an independent trustee on behalf of the company’s employees.  ESOPs seem particularly attractive to engineering and architecture firms.

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?

Michael: Christopher Mercer wrote a terrific book (Buy Sell Agreements for Closely Held and Family Business Owners) on this subject, and many of my views are either directly parroted from or inspired by his writings.  Formulas and preset buy-sell values are doomed to create conflict because one party will feel like the loser in the transaction.  The fair value of the business or business interest is going to deviate from the formula or set number in a way that benefits the buyer or seller disproportionately.  Formulas and set values can also encourage the benefiting party to manipulate a trigger of the buy-sell agreement.  The party on the losing end will almost certainly consult an attorney to fight the agreement.  At that point, the buy-sell agreement has failed to achieve its objective of an orderly exit transaction. 

Mercer suggests listing a group of appraisal firms in the buy-sell agreement that will be asked to bid on the appraisal engagement and carefully detailing the parameters of the appraisal when called upon, effectively writing the engagement letter in advance. 

I also strongly agree with Mercer’s idea of using one appraiser.  Dueling appraisers more often than not just spend more money on the way to the courthouse or the arbitration room.  Hire one appraiser off the list (even the lowest bidder if you need to, as long as you have one objective selection criteria from the group) and live with the outcome.  I have published an article on suggested language for buy-sell agreements to make them more comprehensive and enforceable.

If a broken clock is right twice a day, a valuation formula or fixed number is almost certainly right far less often, if ever.

The fair value of the business or business interest is going to deviate from the formula or set number in a way that benefits the buyer or seller disproportionately.

Q: 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?

Michael: A business needs a buy-sell agreement at the outset of the venture.   The longer you wait, the harder it will be to put in place. 

We do encounter buy-sell agreement issues frequently.  I’m sad to say that we usually encounter the issue in litigation, and we are asked to serve either as an expert witness or an arbiter.

You should put the buy-sell in place when everyone is still friendly, and everyone has a positive outlook on the business and each other.  It’s important to be thoughtful and thorough in the buy-sell agreement by thinking of as many contingencies as possible. Most people consider the triggers of death, disability, and divorce when writing a buy-sell agreement, but what about other instances?  For example, what if a partner suddenly decides he doesn’t want to work anymore?  How do you define that?  Will he be paid the full fair value of his shares, or will the value be discounted?  As another example, let’s say one of your partners is sentenced to jail time.  Will he be paid the full fair value of his shares, or will the price be discounted from fair value?  What if a partner causes the company to be sued?

 

Tina: When should I plan to begin the succession planning process?

Michael: The answer as to when to begin the succession planning process varies case to case, but one answer that fits everyone is “long before you ever think you’ll need it.”  I, and most experts I have heard, recommend at least 5 years before the planned exit. Even 10 years in advance isn’t necessarily too far ahead.

The answer as to when to begin the succession planning process varies case to case, but one answer that fits everyone is “long before you ever think you’ll need it.

Tina: Is there a right or wrong time to have my business appraised?

Michael: Businesses can be appraised at wrong times.  The most obvious wrong times are after a critical event, when the information produced can’t help you, or right before one, when there isn’t sufficient time to produce a credible appraisal. 

I also discourage startup entrepreneurs from commissioning an appraisal for transaction purposes.  There’s not an angel investor anywhere that cares what I think an early stage venture is worth, unless I’m going to be the lead investor (and of course then I’m conflicted).  It’s a waste of precious cash, and it shows the investor that you tend to be the kind of person who “lawyers up.” Also, it calls your business judgment into question.  The last thing I want to do is hurt a client with my work, and that’s what appraising a startup for capital raising purposes will do in many circumstances.

Also, an appraisal in a buy-sell scenario (with or without an agreement) may not make sense unless the other party agrees (or is legally committed) to be bound by the result.  If you want to commission an appraisal for your private planning purposes, then by all means, do so, and that may be a great idea.  But expecting the other party to simply capitulate in the face of an appraisal you paid for is simply not realistic, especially when the other party’s input was not sought.

 

Tina: Why does it cost so much to have my business appraised? Why does it take so long? What are the benefits of having my business appraised?

Michael: The expertise required to perform a business appraisal credibly takes years to acquire, and thus it is expensive to hire, train and retain staff with the skills, expertise and intelligence necessary to carry out the engagements.  Our practice, as is the case with most strong practices, also invests heavily in ongoing professional education, as well as tens of thousands of dollars each year for proprietary data sources.  In that context, I would argue that a business appraisal isn’t all that expensive.  Just gaining access to the data that we use would likely cost the client as much as or more than the appraisal.

The expense also involves the time required to produce a credible appraisal in accordance with professional standards.  Most of our engagements require 40-60 hours of professional time to execute, which involves collecting information, data entry, reviewing of documentation, interviews and (sometimes) site visits, independent research, analysis, report production, review, and quality control.

Ultimately, if a client thinks that a business appraisal is expensive, it means we haven’t successfully articulated the value that the engagement will bring to the client.

I do think our profession often takes too many liberties in terms of delivering work products to clients.  Our practice does a great deal of transaction work, and you can’t take 4-6 weeks to perform an appraisal when there is a transaction being contemplated.  As the saying goes, “time kills all deals,” and the business appraisal firm’s timetable mustn’t be the deal killer.  That’s why one of our key performance indicators for our practice is time to delivery—we call it “engagement velocity.” We deliver our initial findings generally within 2-3 weeks of receipt of information from the client and have been much faster.  For example, we recently completed an assignment in 3 days for a client with a very urgent need.  We might well have saved his job.  We were able to do that because we work hard on process, we have a great team that takes client goals personally, and we have a culture of urgency. 

The key benefit of having your business appraised is business intelligence.  An appraisal performed well should teach the client something (I would argue it should teach the client a lot) that he or she didn’t know at the start of the assignment.  That education will enable you to secure a better deal, to recognize and accept a good deal, to avoid wasting time on deals that are non-starters, to manage a business dispute, to think in a factual way about building value in a business, and to manage a compliance process with minimal time and frustration.  The educational component is particularly critical to sellers.  Many buyers buy businesses for a living. They make 5-10 deals a year and perhaps have been in that business for 20 years.  Most sellers sell their businesses once; they are at a tremendous experiential and informational disadvantage relative to the buyer and are taking a knife to a gunfight.  An appraisal evens the playing field significantly.

The key benefit of having your business appraised is business intelligence.

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

Michael: When buying, selling, or appraising a business, let the facts take you where they lead you.  An appraisal, properly performed, tests a hypothesis, and the scientific method has something to contribute to the discussion.  A good appraiser gathers facts and theories, assesses those facts and theories in the context of the laws of economics and financial markets, and creates a construct (model) to test the hypothesis.  In certain professional standards (such as those espoused by the Institute of Business Appraisers), the appraisal should even be replicable by a third-party appraiser.  An appraisal that is influenced to produce a particular result (either through pressure, limitation of scope, or concealment of facts) is worthless.

 

Tina:  How can I manage the costs of an appraisal?

Michael:  Explaining the intended use and audience of the appraisal to your potential appraiser is critical to managing costs.  For example, if you, the client, are the only intended user of the appraisal, then a Restricted Use Appraisal Report may be appropriate to your needs.  The appraiser puts in the same rigor as with a formal Appraisal Report, but the report itself is reduced to a summary and spreadsheets.  This type of report may be perfectly fine for your needs, particularly in a transaction if you simply plan to use the work product as information to help you assess offers and negotiate.  A Restricted Use Appraisal Report takes significantly less time than an Appraisal Report to produce and thus will be cheaper. 

Perhaps you don’t need an appraisal at all, but rather some research on discount rates or market comparables so that you can perform your own analysis.  In that case, you just need some valuation consulting, and that can be much cheaper than an appraisal.

Rather than commission an appraisal study, you may find it to your benefit to engage a third-party appraisal review of an appraisal.  For example, if you are in a buy-sell situation and your partner presents you with an appraisal he or she commissioned which argues the buy-sell price to be paid, you may choose to have that appraisal reviewed before deciding whether engaging a second appraisal is appropriate.  If you are commissioning an appraisal and are considering whether redundant appraisals should be performed, consider commissioning a single appraisal instead, followed by a review.  An appraisal review requires a fraction of the time and fees of that of a formal appraisal.

How to Get a Premium Value for Your Business

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.