Jeff: Welcome to the Morgan & Westfield podcast. My name is Jeff Allen. It's nice to have you back and listening today. This is the place where people who are interested in buying and selling businesses come for information because we want to make sure that we're doing our job by helping to prepare you to make the right decisions, the right choices when it comes to either buying or selling a business. In order to help us do that, we try to make sure that we have some of the best, most highly recognized and highly prized guest experts on our program.
Today, of course, is no exception. I'm joined by Peter Agrapides. He is the founder of Filotimo Capital Consultants based in Sandy, Utah. Mr. Agrapides has extensive experience in preparing valuations for gift/estate and income taxation and reporting. He has deep knowledge of current valuation-related case law and extensive knowledge of judicial case law as it relates to the valuation industry. He produces a regular column, the Case Law Corner, for the Valuation Examiner which is a national professional development journal published bi-monthly by the National Association of Certified Valuation Analysts.
Peter Agrapides, thanks so much for taking time out of your schedule to join us today.
Peter: Thank you for having me, Jeff. I appreciate the invite.
Jeff: Well, you’re welcome. As always, Peter, we hope that this will be the start of a long dialogue that we'll have with you over a series of shows because there's so much here to talk about and only a short space of time to cover what we really want to cover. Today we're talking about appraisals and valuations from a seller's viewpoint. We're going to go ahead and start off with a leading question for first timers. There might be a number of folks listening to the program who don't have a lot of experience but they've given some thought to selling their business or at least looking into it, maybe kind of getting an education.
What would you say, for example, that a company or an individual has approached me - maybe they could be someone on my network group, they could be someone at the grocery store - and they say, "You know, I know what you do. You guys over there have something that interests me. I'd like to buy your business". Now, from my standpoint, should I plan on having my business appraised?
Peter: Well, I think that's always a good idea. I mean, if somebody comes to you and offers you however much money it is for your business, you need something to benchmark against to know that [if it's] a fair deal, a bad deal, if you could get more, if you could do something to increase the value of the business. A business appraisal would also be able to help you with the transaction in all aspects to make sure that the transaction is structured correctly, to minimize tax exposure, to minimize liabilities and risks further on down the road. But, I think - just from the standpoint of benchmarking the transaction, looking at it to make sure that the number is correct - it's good to have an independent third party appraise or come in and actually value the business. That's one thing with having a credentialed valuation analyst. We're compensated for our time. We're not compensated based off on how low or how high or whatever the number may be. So, yes, I do believe it's a good idea.
In one respect, it may not be something that you need to do. You receive several offers to purchase the business and they're all structured similarly and they're all around the same value, then you may have that benchmark. You may have that comfort level that you don't need to go out and pay for a separate business appraisal.
...if somebody comes to you and offers you however much money it is for your business, you need something to benchmark against to know that [if it's] a fair deal, a bad deal, if you could get more, if you could do something to increase the value of the business.
Jeff: That's interesting. It was going to be a follow-up question. [It] was how many instances are you familiar with or have you dealt with where a business owner did not feel the need to go out and have his business appraised and you answered that question right there. Is it common, Peter, in your business, in your industry from where you sit, to see that many instances where a small business or medium-sized business is actually not appraised prior to going to sale?
Peter: You know it’s probably 50-50.
Jeff: Is that right?
Peter: Yes. Sometimes, you'll see…you know if the owner really tends to be dialed into their professional associations to the M&A trends that are going on within their industry, a lot of times they have a pretty good idea of what multiples the company will sell for. Maybe, they have worked with a valuation analyst or with their CPA a little bit to do some value building in their company. Some simply don't want to pay for the appraisal. But I would say it's about 50-50. I mean, when I'm valuing a business, I do rely somewhat on that owner. At least it's a due diligence question that I ask them if, "Are you aware of any transactions within the industry? Any roll ups within the industry, anything like that?" And you'd be surprised [at] how many owners that are more sophisticated or pretty dialed in, and they have a pretty good idea of at least a reasonable value range for where their company would be priced.
Jeff: So it pays to really look around, be aware of your competition? Be aware of the guys across the street and the folks across the country and have an understanding of . . . at least the basic understanding so you'll know the questions to ask if you decide to work with an appraiser or not --- if you decide to do your own due diligence as far as that goes. Now, is there any difference, Peter, between a valuation and an appraisal or are they essentially just two different words for the same thing?
Peter: In technical terms, there's a difference. In layman's terms, as they're used within the industry or within the advisory community - with the CPAs, attorneys and stuff like that - they're the same thing.
In technical terms, an appraisal is usually the term for determining the worth of a tangible asset. Okay? So Real property, machinery and equipment, vehicle, home, anything like that that's tangible --- it's an appraisal. Anything that's intangible to the value of your business --- the goodwill, the trade name, the website name . . . any other type of intangible asset where intellectual property, we term it a valuation. In a valuation report, you'll see I'm very clear with how I use those two terms because sometimes, in my valuation, maybe there are tangible assets that need to be appraised and I make that distinction within the report. Don't expect that from me if you run in to me on the street. I'll probably use the two terms interchangeably as well anybody else.
Jeff: Okay. Then that's a great jumping off place, then, to ask you. You talked about the difference, the intangible versus the tangible values, so, you're talking about intangible intellectual property - include[ing] websites and things like that - in the intangibles, is that correct?
Peter: That's correct.
Jeff: Why would I not, as a business owner, want to include everything? Because if I'm selling everything - lock, stock and barrel - maybe I want to retire. Maybe I don't have an heir in my family or sons or daughters to take over my business. I just want to be free of it. Why would I not want to include everything in my appraisal?
Peter: Generally, you would. You would want to include everything that is associated with that business. You're not going to sell the business and say, "Hey, I'm going to keep the website" . . .
Peter: Or "I'm going to keep the trade name", okay? The only times that you would not keep everything that you have in your business is just, let's say you have non-operating assets. So, a lot of times, you'll see a company that maybe has real property. They've got a condo somewhere or a fishing lodge or they've got a boat or something like that that's included into the business. It needs to be appraised separately and we term it a non-operating asset because the business can continue the function even if that asset is pulled out the business. So, the company would sell and those non-operating assets would be retained or held by the owner. So the owner wouldn't receive any compensation from the buyer when they sell the business. They would just sell the business and retain the non-operating assets.
The only times that you would not keep everything that you have in your business is just, let's say you have non-operating assets.
Jeff: Okay. Now if business broker offered me a free valuation, why then should I pay for an appraisal? Now, keeping in mind we discussed the difference between a valuation and an appraisal, but should I be content with that free valuation or should I really pony up the extra money and have a full appraisal done?
Peter: Knowing how a lot of the brokers pricing opinions are done, a lot of those are just done looking at multiples . . .
Jeff: Got it.
Peter: Looking at a multiple of revenue in particular industries, looking at the multiple of revenue in the particular industries which is a relevant marker for value, but I think having a professional appraisal done, again, is wise because we're going to get in there, and we're going to really take a look under the hood. We're going to look at what's the true cash flow of the business. You know as every business owner knows you have two things that you're balancing. You want to maximize your cash flow, somebody is obviously buying your business. You want to minimize that for income tax purposes . . .
Peter: We would go in and, what we call, normalize the cash flow to get the true economic income of that business. That may not be done in a broker's pricing opinion.
Jeff: So . . . you're . . . so . . .
Peter: And again . . .
Peter: Go ahead . . .
Jeff: No. It's just that . . . my question was that, I understand through your response that . . . by paying for that appraisal - which really gets into the nitty-gritty and into the details - I could really probably gain greater value from the sale of my business based on the information contained in that appraisal. I could be losing, leaving money on the table, without that, correct?
Peter: Sure. Sure.
Knowing how a lot of the brokers pricing opinions are done, a lot of those are just done looking at multiples.
Peter: And there could be motivation from the brokers . . . if the broker wants to sell the business quickly and maybe offer it at a lower price or something like that.
Peter: Optimally, somebody should come to an appraiser two, three, four years before they're ready to sell the business so we can take a look at it, see what it's worth, and then maybe also give them a little bit of consulting advice as to how they can maybe increase the value of that business and having that discussion also with the business broker. Because they're going to have the real market intelligence for our businesses in this industry --- selling them, are they not selling, is it a buyer's or is it a seller's market. So, it's really a team approach when somebody is taking to selling that business. It's a complex asset and it's a real team approach to get everybody involved and everybody around the table start planning years in advance.
Jeff: Very good. You're listening to the Morgan & Westfield podcast series and my guest today is Peter Agrapides, MBA, CVA founder of Filotimo Capital Consultants in Sandy, Utah. He is an expert in the area of business appraisals. My name is Jeff Allen. I sure do thank you very much for tuning in.
Peter, let's say a venture capitalist has valued a business using a discounted cash flow approach. And that same business had a business appraiser value their business. And the appraiser came up with the value that is 50% less than that returned by the venture capitalist in that study. Did someone make a mistake? I mean, how does that business owner know which one is accurate?
Peter: First off, it pays to know what each of the valuations was done for. If the venture capitalist did it for business sale and let's say, the business appraiser had done that for shareholder dispute or another litigation matter, maybe a divorce or something like that, it's not an indicative that somebody made a mistake, okay?
Peter: We have what are called standards of value. Generally, the highest standard of value is what we call the investment value. That's where somebody's coming in to buy a business and they can . . . there's some economy of scale or something that they can exploit by combining that business with a particular resource that they have. So they're willing to pay more. They're willing to pay, let's say a dollar twenty. They're paying a premium for every dollar of cash flow in that business because they know that once they combine whatever resource they have - their business, their technology - whatever it is, they're going to get an enhanced level of return on that. Where what we're normally looking at for purposes of, let's say cash valuation - for gift tax, state tax, income tax - anything that's going to the IRS for federal income tax purposes, we're looking at fair market value. Specifically stated in Revenue Ruling 59-60, it specifically states that not to take into account any of those synergies or any of those economies of scale. So, if you have a valuation done on the exact same company on the exact same valuation date of the exact same interest, you can have widely divergent values just because of the purpose of the valuation if the standard of value is different.
The second issue that you have there is with the venture capital valuation, with their DCF--we need to know who prepared that projection. Who prepared the forecast, okay? If the venture capitalist prepared it, maybe they wanted to paint a very rosy picture to attract capitalists, they're going to do a round of financing and this is something we see all the time where maybe the management of the company has done the forecast and they've done it for capital raise or something where they want to paint a very rosy picture of the business and the forecast is just not attainable. Now, we'll work with them in . . . looking at industry information, looking at what we can find to make the projection more reasonable and generally lowering the value of the business in doing that.
... if you have a valuation done on the exact same company on the exact same valuation date of the exact same interest, you can have widely divergent values just because of the purpose of the valuation if the standard of value is different.
Jeff: Peter, are there different types of appraisals? We know there are different types of approaches, I mean, what are some questions that someone, a business owner, should ask if they've contacted an office like yours about the type of appraisals that are available and which are right for them and their particular business?
Peter: That's a great question especially in our [the] context of what we're talking about today. You definitely have different, basically, levels of engagement services, okay?
Peter: If somebody is calling, the first question you ask, "Hey, somebody wants to buy my business. I want to know if the number's reasonable. I don't want to communicate the number to you but I'll give you my financials. Can you tell what you think the business is worth?"
For something like that, we can do what's called a calculation of value. A calculation of value is where I sit down with my client and I say, "Look, here are the methods and approaches that we're going to use to value the business. We're going to go in, we're going to do all of our due diligence but I'm not going to write an eighty-five page report just to help you make a decision. It's a decision tool, okay?" Now, if that same client comes to me and says, "Look, I'm gifting away with 49% interest in my company. We need you to value the business for reporting purposes. We need to report this as a gift to the IRS. We want to get the three years' statute running where they can come back and audit for only a three-year period. Will you value the business?” The number would be the exact same. Let's say we're appraising a 45% or 49% interest. In both instances, their number would be the same. But in the second example where that report or that analysis is being used for reporting purposes . . .
Peter: …we have to issue what's called a full conclusion of value as per standards that are promulgated by the National Association of Certified Valuation Analysts or whatever accrediting body the appraiser is actually accredited through. If anything is being done for reporting purposes, it's going to be a higher level of service and a higher level of cost because we're not just coming up with the number, we're explaining everything in the report that helped us come up with that number. And there's several bullets that we have to hit in terms of different items that we include in that conclusion of value report. But for somebody who's just looking to get a number to sell a business and they just want to use this in their decision tool box and something that they can use with their advisory team, the approach that I tell them is, "Hey, let's do this. Have your attorney engage me." That way everything that we do is protected by attorney-client privilege. If it's protected by attorney-client privilege, it's not discoverable. So anything that comes up - if ever a lawsuit or if we do have to kick it up to a full conclusion of value - and maybe that number difference from our calculation of value, that calculation of value is not discoverable, we’re not chasing our tails having two different numbers running around.
If anything is being done for reporting purposes, it's going to be a higher level of service and a higher level of cost because we're not just coming up with the number, we're explaining everything in the report that helped us come up with that number.
Jeff: Peter, I know that you have quite a vast level of experience in dealing with attorneys and in working with legal teams and so, you're speaking from really a strength of experience there and depth of experience in that particular area. You touched on valuation of businesses for more than just business sale but also for tax purposes. Are there some other instances where someone might want to get a valuation on their business?
Peter: Sure. I mean, tax, like I said, is a big one --- both income tax or [and] what charitable donation purposes, transfer tax which is gift and estate. Bankruptcies. You also have asset allocation, again, for tax purposes. So, if somebody sells their business and they want to retain or report on their income tax that some of the sale was personal goodwill as opposed to enterprise goodwill, we can allocate the assets out separately. So, we go through and say, "The website's worth X. The customer list is worth Y. You know, parse out every tranche of assets. Like I mentioned before, divorce purposes, lot of different litigation purposes, shareholder disputes. We do a lot for SBA lending for business owners. Maybe they're buying a business. Just like when you buy a home, the home has to be appraised.
Peter: They go buy a business, and they do an SBA 7[A] loan. That evaluation is almost identical to the valuation that we do for tax planning, for reporting back to the banks. There are a whole myriad. We do a lot now for higher net-worth clients that are expatriating, that are basically revoking their citizenship and moving to another country. Maybe their business is already located in another country.
Peter: That type of thing.
Jeff: Peter Agrapides is the founder of Filotimo Capital Consultants in Sandy, Utah. We're talking to him about business valuations today and business appraisals. This is a Morgan Westfield podcast. My name is Jeff Allen. Thanks again for tuning in today. It's nice to have everybody here.
What about those businesses that are global in scope. Perhaps they're online businesses. They do a lot of, maybe, the retail sales. Maybe they're business to business and they do a lot of selling to companies overseas. What's the difference in that process? Should the business owner, someone whose doing . . . they could do anymore from a hundred thousand to a million dollars in sales a year. Do they also need to have their business appraised if they're going to sell that, Peter?
Peter: I would think so, I mean, especially with something like that because it's more of a niche business. Those are generally a little bit more difficult to value because they don't have a lot of comparables . . .
Peter: We're going into the public market place. There may not be a lot of public companies that we can compare. Or the company's too small. If it's a really niche business, there may not be any transactions of similar privately-held companies. So, it's really sitting down and building up our cap rate or capitalization rate which is what we use to convert the company's cash flow into a present value, the value of the business. But it's really going through, looking at country-specific risk factors, looking at various industries-specific risk factors, looking at, maybe, supplier concentration issues, customer concentration issues, regulatory issues which can constantly change and change very rapidly for a global business. I think that's equally important for that type of the business to have a professional valuation done.
Jeff: Some companies, entrepreneurs, perhaps, with the best of intentions, they set up a business and they've had some success but they just weren't able to make it work and accomplish their goals, their business goals. But that company has a lot of potential. This business, this particular industry has a lot of potential. And again, we're just kind of making something up here at the moment but I know that you've probably run into a situation, maybe not necessarily directly involved with your business, Peter, but you've probably heard of situations where maybe somebody wanted to try to get as much as possible for their business, for the sheer potential that it has despite the fact that they can't turn it around and do something with it. Can people get paid for that? I mean, is it possible to put a value on potential, when you're talking about providing valuation or appraisal of the business?
Peter: Absolutely. Absolutely. One of the purposes that I actually neglected to mention was stock-based compensation valuations or 409(a) valuations. Where we see a lot of those, they're really concentrated in the bay area --- Palo Alto, San Francisco. There are a lot of start-up early-stage development companies that have no earnings. Some of the companies don't even have revenues. They've got an idea, they've got technology but they either lack the resources or they haven't had the time yet to monetize those resources. If you look at the valuations that we do to those companies, they have significant value. That value could be, for all intents and purposes, "here today, gone tomorrow". Somebody else comes in with a better technology or they're just not able to get over the crest of the hill and actually monetize if that value's gone. For the time being, they have very high valuation. What we look at with those is we stay away a little bit from the three approaches - the income, the asset and the market approaches - and we rely more on what are people paying for the business in terms of when they do a capital raise? Is there raising money through a preferred of stock offering or a [Class A] offering? We look at the time frame. How far back was the last capital raise? How much capital was actually raised? And then we do some optional analysis to distill that value back, maybe, into a common stock value but yes, you can get paid for the potential. It's obviously a more volatile-type of valuation because if it doesn't pan out, that value's gone and they can be gone very quickly.
Jeff: Peter, I'm down to my last minute or so and as we wind things up, last thing I'd like to ask you today --- you've got Mr. and Mrs. Business Owner out there, Miss Business Owner out there. They want to sell their business there. Looking into it, what should they do? What is the first thing they need to consider doing or how do they prepare to sell that business? What are the first steps?
Peter: First steps will probably be get their CPA involved and a valuation analyst. Have somebody go through the financials. First off, make sure they're clean. Make sure there's not a lot of flaws in there in terms of non-business activity and what-not going through there paying for personal expenses . . . that type of thing. Make sure that you have quality financials, whether they’re reviewed or audited. Have those done for a few years, so, whoever's looking at those financial have some degree of confidence that at least somebody else has put their professional reputation on signing off on those financials. So that would be the very first early-stage steps as well as getting a team together to look at the entire business sale, the tax consequences, the liability consequences. Somebody, an investment banker that has a good network, a good reach that can monetize that business quickly.
First steps will probably be get their CPA involved and a valuation analyst. Have somebody go through the financials.
Jeff: Peter Agrapides, you've been a wonderful guest. We are going to have to leave it there unfortunately. We've run out of time. Hopefully you'll join us again here in the near future.
Jeff: Thank you again to Peter Agrapides for joining us today on the Morgan & Westfield podcast presented by Morgan & Westfield, a nationwide leader in business sales and appraisals.
If you'd like more information about buying or selling a business, call Morgan & Westfield at 888.693.7834 or visit morganandwestfield.com. Until next time. I'm Jeff Allen.