Mergers & Acquisitions

Resources: Interviews with Industry Experts

Our goal at Morgan & Westfield is to provide you, our readers, with high quality information and valuable resources to help you navigate through the process of buying or selling your business. In this section, we provide interviews from various professionals somehow involved in the process of buying or selling a business.

Eric Sundheim

Accredited Member of the American Society of Appraisers

Eric Sundheim, a Vice President in the valuation practice at Teknos, joins us today to discuss topics that all business owners should understand before selling a business. Mr. Sundheim explains how a business owner can choose the right business appraiser and what one should know about a business appraiser before hiring him or her. Further, Mr. Sundheim explains the mistakes many business owners make when setting a price for a business.


Key Points from Our Conversation

  • “A valuation credential is a sign of a qualified business appraiser and indicates that he or she is someone who keeps up professionally with the discipline of appraisal.”
  • “it is most essential that the appraiser is someone who is skilled and competent in appraisal techniques and financial analysis before even considering the necessity of his or her industry expertise.”
  • “Appraisers are experts at understanding the impact of size, growth, risk, and margins on a multiple and in reconciling the values implied by various methodologies for determining value.”

Interview

Tina: What are some questions to ask potential business appraisers before hiring one?

Eric: It is essential that the appraiser you select is able to effectively communicate information to others – including you. So ask them anything: “What are my options?” or “What are the steps in this process?” or “What will the key inputs be?” and see if their answers make sense to you. If they cannot answer these questions well, they probably will not be able to explain their appraisal findings in a manner that is meaningful and helpful to you.

Experience (and good experience at that) and competence are qualifications you will need to discern, either through references or through obtaining a list of the appraiser’s publications and accomplishments. It is also a good idea to ask the appraiser about his or her professional designations – and that means appraisal designations. It is possible to hold each a CFA, CPA, MBA, and a PhD and still lack competence in the field of appraisals. Some of the credentialing appraisal organizations include the ASA American Society of Appraisers (ASA), the National Association of Certified Valuators and Analysts (NACVA), the Institute of Business Appraisers (IBA) and the American Institute of Certified Public Accountants (AICPA) (the valuation designation granted by the AICPA is the ABV – not the CPA). A valuation credential is a sign of a qualified business appraiser and indicates that he or she is someone who keeps up professionally with the discipline of appraisal.

It is essential that the appraiser you select is able to effectively communicate information to others – including you.

Tina: What are the differences between a real estate appraisal and a business appraisal? Can the same appraiser do both?

Eric: There are a number of appraisal disciplines, including business, real estate, machinery, and personal property. Real estate or real property appraisers value land and improvements thereon. This can be residential property, office buildings, or shopping centers. Business appraisers value entire businesses, including their intangible assets.

Business appraisers do not pretend to be real estate appraisers. The converse is not always true. If you need your business appraised, hire a business appraiser. Some businesses, such as golf courses, hotels, or bowling alleys, may have special purpose property that is a major asset of the business. In these cases, you will need both a business and a real estate appraisal. Your business appraiser can rely on the work of a real estate appraiser (typically obtained through subcontract) to develop his or her opinion of value. There are a few “Bo Jacksons” that are qualified to appraise both, but they are rare.

Business appraisers do not pretend to be real estate appraisers.

Tina: Can any business appraiser value any type of business, or do I need to find one with industry expertise?

Eric: Generally speaking, a certified business appraiser can perform an appraisal for a wide variety of industries. However, certain industries present unique challenges that require non-standard valuation methods that a more ‘generalist’ appraiser may not be familiar with. In any case, it is most essential that the appraiser is someone who is skilled and competent in appraisal techniques and financial analysis before even considering the necessity of his or her industry expertise.

Tina: What unique valuation challenges do emerging growth companies present?

Eric: Emerging growth companies require appraisers with unique experience valuing these types of businesses. The majority of appraisals concern established companies with meaningful historical financial data and low to moderate growth and risk profiles. Traditional valuation models, such as a capitalization of cash flows, or the application of a multiple to “normalized” historical financial data are of little use to companies that do not have positive cash flows, or even revenues. A biopharmaceutical company that does not yet have a product that has received FDA approval certainly may be valuable – and it may be very valuable at that! These companies require appraisers skilled and experienced in applying the valuation methodologies relevant to their stage of development.

Traditional valuation models, such as a capitalization of cash flows, or the application of a multiple to “normalized” historical financial data are of little use to companies that do not have positive cash flows, or even revenues.

Tina: What is the difference between a "valuation engagement" and a "calculation engagement"?

Eric: Various entities have developed classification systems for valuation engagements and their associated deliverables. The AICPA defines two types of valuation engagements: valuation engagement and calculation engagement. The ASA defines three types of valuation engagements: appraisal, limited appraisal, and calculation. The distinction here boils down to the scope of work and the type of opinion expressed (if any). A calculation does not express an appraiser’s concluded opinion of value and may rely on limited information and pre-determined methodologies. ASAs also need not comply with the Uniform Standards for Professional Appraisal Practice (USPAP) if they do not express an opinion of value. The purpose of the report may preclude these limited forms of appraisal.

Even if the appraiser performs a full-scope appraisal, he or she may deliver a report that does not fully detail his or her analysis or conclusion. The AICPA distinguishes between written reports that are detailed vs. summary reports, and also permits oral reports. USPAP distinguishes between Appraisal Reports and Restricted Appraisal Reports. The purpose of the report may preclude limited reporting options, but you may want to request a reduced level of detail if you think the cost of obtaining this detail outweighs the benefits.

Tina: What are the general fees for a business appraisal for M&A purposes, or for a business owner looking to sell their business?

Eric: Valuation fees vary based on the scope of work, required turnaround time, and quality of appraiser hired. If you are entertaining the idea of selling your routine business and just want someone to give you an oral ballpark estimate of its value, you can get that done without great expense (a few thousand dollars). If you want a written appraisal of your unique startup this week and want the appraiser to take part in your negotiations, you will need to pay more.

Tina: What are the most common mistakes that sellers make when setting a price for their business?

Eric: Both sellers and buyers can get hung up on rules of thumb. They like to remember one rule to valuing a business, typically a rule that is favorable to them, and ignore other relevant data. While it may be true that some businesses sold at a price that was “1x revenue”, for example, not all of them do. In some industries, multiples may be extremely important – but it is important to understand (1) why a particular multiple is relevant and (2) why that multiple might be 1.5x for one company and 2x for another. Revenue multiples, for example, implicitly incorporate margin, growth, and risk expectations. Appraisers are experts at understanding the impact of size, growth, risk, and margins on a multiple and in reconciling the values implied by various methodologies for determining value. You spent a lifetime developing the skills necessary to develop a saleable business: Do not short-change yourself by spending a minute understanding its value.

It is most essential that the appraiser is someone who is skilled and competent in appraisal techniques and financial analysis before even considering the necessity of his or her industry expertise.

Tina: What valuation methodologies are used to determine a price for a targeted company? Does financial due diligence have an impact on the valuation?

Eric: All valuation methods can be classified under the Income Approach, the Market Approach, or the Asset Approach.

  1. The Income Approach is based on the premise that the value of a business is the present value of its future earning capacity. It involves estimating the discounted cash flow for the business by projecting the free cash flows each year, calculating a terminal value, and then discounting these cash flows back to a present value at an appropriate discount rate (taking into account the time value of money and the risk inherent in that business).
  2. The Market Approach is based on the premise that a business can be valued by comparing it to other companies that were publicly traded or have been acquired. It involves estimating the value of a business by looking at actual transactions in the equity of similar companies, whether the transactions involve a full or partial interest in such companies.
  3. The Asset Approach is based on the premise that the value of a business is the cost of replacing all of the assets of that business, both tangible and intangible. It involves estimating the cost of reproducing or replacing all property in the business, less depreciation for physical deterioration and functional obsolescence.

Multiple methods typically indicate different values for the subject entity . Appraisers must apply judgment in determining which method or combination of methods to rely upon. One of the key considerations is the reliability of the underlying data and assumptions involved. Financial due diligence may certainly have an impact on the valuation given that the due diligence aims to validate the assumptions used in the valuation methodologies. For example, due diligence on a method under the Income Approach would assess the accuracy and reliability of the assumptions used to project future cash flows. Depending on the results of such diligence, the expected future cash flows may change, which in turn could have a significant impact on the valuation.

Even if the appraiser performs a full-scope appraisal, he or she may deliver a report that does not fully detail his or her analysis or conclusion.

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

Eric: In my experience, too many potential deals are not consummated because one or both parties focus too much on the bottom-line price and not enough time listening and learning how the other party views the transaction. Also, they fail to fully utilize the skills of their experts. Focusing on “I want $5 million for this business and not a penny less” may prevent that party from working with their experts to identify creative alternatives that will enable them to meet or exceed their expectations.

We all make assumptions which form the basis of our position. It is important we take the time to learn what assumptions underlie the other party’s position. In doing so we may uncover facts that can take a deal from life-support to a successful closing . For example, both parties may hold different expectations regarding the target company’s future revenue growth. In such a situation, the merger agreement could specify some type of earn-out , making the consideration (and thus value) dependent on the actual future performance. These types of problems are not new and attorneys and brokers have developed agreements to address them – so take advantage of their expertise.

Similarly, I advise you to get the most out of your valuation report. Don’t let some other party (or yourself) discount your valuation because “it doesn’t consider _____.” If you think the valuation conclusion is too low because it doesn’t account for the impact of a buyer-specific synergy or a potential non-compete clause, your appraiser can explicitly assess the impact of these characteristics on value. Few things are priceless as far as we are concerned.


Eric Sundheim’s Bio

Eric Sundheim, AM
Teknos
350 Cambridge Avenue, Suite 300, Palo Alto, CA 94306
(650) 330-8810
esundheim@teknosassociates.com
www.teknosassociates.com

Eric Sundheim is a Vice President in the valuation practice at Teknos. He has significant valuation experience and has completed more than 200 valuation projects including purchase price allocations, M&A consulting assignments, stock option analysis for financial reporting purposes, intangible asset valuations, complex security valuations, and analyses for expert reports to support litigation.

Prior to joining Teknos, Eric was a Senior Consultant at Precision Economics where he prepared expert reports for valuation, transfer pricing, and public policy.

Eric received a BA in economics from Washington University. And he has received the designation, Accredited Member (AM), from the American Society of Appraisers.

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