Selecting the Right Appraiser

As a business owner, one of the most important questions you’ll ask yourself is: What’s my business worth? To answer this question, most business owners pay a professional to value their business. Before you do the same, be sure you consider the following: 

• What type of valuation is best for your situation?
• How should the methods used to value your business change based on the type of buyer most likely to buy your business and the size of your business?
• Should you have an appraiser, a broker, or a CPA value your business? 
• How much does a business valuation or appraisal cost? 

Each of these questions will impact who you choose to value your business and the end value they arrive at for you. Next, I’ll describe each of these factors in more detail. 

The Process for Valuing a Business

While there aren’t universally standard steps to valuing a business, and the method can change depending on who you hire and the type of valuation you’re looking for, here’s a general outline of the process most professionals use to value a business: 

1. Data Gathering: Most appraisals start with an analysis of three to five years of your profit and loss statements, balance sheets, federal income tax returns, and a company questionnaire. While this stage of the process is most likely the most exciting part for CPAs, the data-gathering process is the most time-consuming part of the undertaking for you. This is because it involves gathering a large amount of financial and operating information on your company. 
2. Analyze and Normalize Financials: Once the appraiser has this information, they’ll normalize and analyze your financial statements by inputting them into a spreadsheet. This step also involves making adjustments to your financial statements to calculate EBITDA so your business can be compared with others in your industry. 
3. Additional Questions: The appraiser will need to communicate with you during this process since your involvement is key to the accuracy of the appraisal. 
4. Compile the Report: Once this step is complete, the appraiser will compile the report based on the information you’ve provided, as well as information the appraiser has already obtained about your industry.

Choosing the Right Type of Valuation

When considering whether you should have your business appraised, you have several options available to you. The various types of business valuations don’t have standard definitions, but most reports fall into one of three main categories: 

1. Verbal opinion of value
2. Written report for non-legal purposes, such as a business sale
3. Self-contained or formal appraisal

Verbal Opinion of Value

A verbal or oral opinion of value is suitable for any business owner who doesn’t need a written report. This type of valuation usually involves the appraiser, broker, or CPA reviewing your financial statements and offering a verbal estimate of value. Some M&A intermediaries offer this service for free, while most experienced experts will charge a fee. These types of reports are useful if you’re in the exploratory stages of selling your business and would like a ballpark idea of what your business is worth before committing more time, money, and effort to the process. A formal report isn’t essential for most businesses. 

Written Report for Non-Legal Purposes

This is sometimes called a Restricted Appraisal Report. These reports don’t comply with appraisal standards and can’t be used for legal purposes. Written reports can range from a couple of pages to 50 or more pages. I generally refer to these reports as a “business valuation, not for legal purposes.” The format of these reports varies considerably because they aren’t standardized. Some are simple and straightforward, while others are long, formal, and full of technical jargon that have little practical application in the real world. A “calculation of value” is the industry’s attempt to offer a simplified report for business owners. Costs for these reports can range from free to tens of thousands of dollars. These reports are most useful for business owners looking to sell a business. 

Self-Contained Appraisal

This type of report, also known as a formal appraisal, is required for any legal purpose, such as divorce, tax matters, or bankruptcy. These reports are often hundreds of pages in length and are of little use for a business owner looking to sell a business. Prices vary widely but usually run at least $5,000 or more. The format of self-contained appraisals is more standardized and, therefore, more consistent. Unfortunately, because of this standardization, self-contained reports are complicated, filled with legal jargon and formulas, and take more time and money to prepare. This standardization often means that not only are these reports too esoteric to be useful in the real world, but they’re prepared by business appraisers and CPAs, many of whom have never actually sold a business. This leads to the question – would you pay an appraiser thousands of dollars to value your business if they’ve never sold a business before? I wouldn’t. And generally, you don’t need this type of appraisal unless it’s being used for legal purposes.

Would you pay an appraiser thousands of dollars to determine the value of your business if that person had never personally sold a business before?

Choosing an Appraiser Who Will Use the Right Methods 

To complicate matters further, not only are there different types of valuations, but there are different methods that appraisers use. Different types and sizes of businesses use different benchmarks, and the value of a business can change based on the methods that are used. Here’s a more detailed explanation of why appraisal methods vary:

Methods for Small vs. Mid-Market Businesses vs. Large Businesses

The methods used to value a small business are different from those used to value larger businesses. Unfortunately, most valuation software doesn’t make this distinction, and you sometimes end up with a report that isn’t suitable for your business. When obtaining a business appraisal, ask the appraiser the industry and size of businesses they sell and value on a regular basis, and the methods they most commonly use to value a business. 

The Right Standard of Value for Appraising Your Business

Most business appraisals use fair market value (FMV) as the standard of value. FMV doesn’t consider the strategic value of a business to the buyer. Therefore, any business appraisal using FMV as the standard of value for a middle-market company is unlikely to represent what your business may actually sell for. Ask your appraiser what standards of value they will use to appraise your business.

How Buyer Types Affect Your Valuation

The task of valuing your business is complicated by the fact that there are different types of buyers. Some buyers, such as private equity firms, are looking to buy a business as an investment to be run by a management team. Others may consider your business as a strategic addition to a similar business they already own, in which case they may be able to reap synergistic benefits. Your business’s size and type will determine the type of buyer interested in your business, which will, in turn, determine the multiple the buyer is likely to pay. It stands to reason that whoever appraises your business should be intimately familiar with who’s likely to buy it.

Choosing the Right Appraiser 

When choosing an appraiser, your options include M&A firms, CPAs, and business appraisers. Who’s right for your situation? And how much does a valuation cost? Do you need to pay $10,000 for an appraisal, or should you trust a free valuation? The following are the advantages and disadvantages for your three primary options for having your business appraised: 

• M&A Firms: Many merger and acquisition firms, as well as other intermediaries, offer valuation services to their clients. These firms will provide a simplified valuation report and focus on the value of your business solely in the context of a sale. A major advantage of M&A firms is that they have experience buying and selling companies and are well qualified to advise you on the value of your business in the actual marketplace, as opposed to the theoretical legal world. They’re also usually well-versed in both strategic and other corporate buyers. Additionally, the value of most middle-market companies is established through an auction process, and M&A advisors are experts in using private auctions to sell a company. They can advise you on the relationship between the price you may achieve through an organized auction process and the baseline value shown in a valuation report.
• CPAs: Accountants and CPAs sometimes offer valuation services to their clients. Some CPAs are also licensed business appraisers. While accountants have a strong grasp of the numbers, few have sold a business before and aren’t an ideal choice to prepare a valuation for M&A purposes. On the other hand, larger accounting firms have dedicated M&A professionals on staff and may be more qualified to do so if they have experience selling businesses.
• Business Appraisers: Business appraisers are the most qualified professional to value a business for legal purposes. Unfortunately, most lack real-world experience selling companies and shouldn’t be used to value your business for a sale. 

The different appraisers might seem overwhelming at first. Regardless, the decision should be made within the context of your goals.

• The Best Appraiser for Legal Purposes: When obtaining an appraisal for legal purposes, select a business appraiser or a CPA who is a licensed appraiser.
• The Best Appraiser for Selling Your Business: M&A intermediaries with real-world experience selling companies are ideal when the purpose of your valuation is to sell your business or weigh your exit options. When selling your company, you don’t need an appraisal that’s designed for legal purposes, or that can be used in court. As a result, your advisor can produce a shorter report that’s limited to the valuation methods that buyers use in the real world, which will save you time and money.

The Cost of a Valuation – Research Based on 44 Companies

I contacted a random sample of 44 M&A intermediaries, investment bankers, business appraisers, and CPAs to see what they would charge for appraising a middle-market manufacturing company. Not surprisingly, their fees ranged widely, from “complimentary” to as much as $40,000. The more knowledgeable and experienced an expert is, the less likely they are to offer anything for free. After all, how much does someone value advice if they’re willing to give it away for free? Fortunately, free appraisals aren’t common in the middle market. Most M&A advisors selling businesses valued between $5 million and $100 million don’t offer any form of a free valuation. 

Can you expect to get what you pay for? Since there’s no standard format for valuing companies that are for sale, you can expect that a free appraisal won’t be nearly as comprehensive as a $40k valuation. Still, depending on your circumstances, you may find that an appraisal on the lower end of the price spectrum could suit your needs. Consider this your first round of comparative shopping.

M&A Firms

• Range:
  • $1,500 t0 $2,500 for a limited report
  • $5,000 to $15,000 for a full report
• Average: $7,000

Out of the 24 M&A firms I contacted, almost half didn’t recommend an appraisal at all. Several recommended going straight to an auction process, thus bypassing an appraisal, while a couple recommended a third-party appraisal. One of the firms offered a free valuation for prospective clients, another asked for a 5% retainer based on the valuation, and a third charged an hourly rate of $350.

Investment Bankers

• Range:
  • $12,000 to $17,000
• Average: $14,500

Of the two investment bankers I surveyed, only one provided concrete pricing ranging from $12,000 to $17,000 for their process, which takes four to five weeks. They didn’t suggest setting a price for the company, as they recommended an auction process with no price. They also advised us to pursue the strategic value rather than the fair market value. The other investment banker didn’t provide pricing because their costs vary based on a number of factors. They also mentioned attempting to achieve strategic value. 

Business Appraisers

• Range: 
  • $2,000 to $10,000 for a limited, short, or verbal report
  • $3,500 to $30,000 for a full report
• Average: $11,000 

Nearly half of the business appraisers I spoke with offered a limited or verbal report with options to upgrade at a higher price. These limited reports ranged in price from $2,000 to $10,000. Only one of the 12 business appraisers discussed standards of value based on the purpose of valuation, while two said they could prepare reports specifically for legal purposes.

CPA and Accounting Firms

• Range: 
  • $2,000 to $3,000 for a verbal report
  • $5,000 to $15,000 for a calculation or full report
• Average: $8,000

Two of the four accounting firms I contacted could provide reports specifically geared toward business evaluations. One proposed a low-priced verbal opinion for $2,000 to $3,000. Another firm suggested preparing an 80-to-100-page report specifically for tax and other compliance purposes.

Financial Advisory Companies

• Range: 
  • $10,000 to $40,000
• Average: $22,500

As you can see, the two financial advisory companies surveyed offered the highest costs with a $40,000 appraisal. Another firm supplied valuations for business sales on an hourly basis, and charged $10,000 or more for appraisals for legal purposes.

Conclusion

Here’s the bottom line – businesses are measured by the bottom line. Yes, a business’s potential can enhance its value – especially if that potential is close to being realized – but don’t expect the buyer to pay a lot for a promise that has yet to be entered into the ledger. The primary value driver of your business is profitability that can be demonstrated.

And, yes, there are other variables that buyers may consider when purchasing a business, but the majority exclusively look for one thing, and one thing only – profit. When valuing your business, focus on the two methods most buyers use to value a business:

1. Multiple of EBITDA
2. Comparable Sales

To increase the value of your business, focus on increasing your EBITDA or increasing your multiple.

The issue of who you’re dealing with matters, too. As a business owner, you understand the value of knowing your customer. You wouldn’t be here if you weren’t adept at identifying the audience for your product or service and knowing how to reach them with the right prices. The same holds true when it comes to selling your company. It’s essential that you and your appraiser are familiar with the various types of business buyers and their motivations. Some buyers are looking to acquire a business as an investment that will be operated by a manager. Others might be attracted to your business for synergistic reasons. The difference matters when determining the multiple the buyer may pay.