Tina: Is there a difference between an “appraisal” and a “valuation”?
Joshua: Generally speaking, and as far as our clients are typically concerned, there is no difference between an appraisal and a valuation. Both terms are frequently used interchangeably by both clients and professionals alike. However, I read a book a few years ago, "The Business of Business Valuation", which in my opinion best illustrated what the difference was from a theoretical standpoint. An appraisal is the assignment of value to tangible assets such as equipment and real estate. A valuation is the assignment of value to intangible assets such as a business interest or intellectual property. Others may have their own opinions, but that is the simplest way I have found of explaining the difference.
Tina: Do you need to visit my business to complete the appraisal?
Joshua: As with all assignments, it depends. From our perspective, it is always better to see the business operation and visit with management than not, as there is more to a business than the financial statements and seeing the business first hand greatly enhances our understanding of it. However, for engagements we perform for financing purposes, the bank is generally our direct client, and therefore the bank performs a majority of the requisite due diligence, which includes a visit to the business to ensure that it exists and manufactures widget X or performs service Y. In this case, the appraiser would not have to typically visit the business, and we would then perform a phone interview or have the business owner come to our office.
On the other hand, for litigation assignments such as marital dissolutions and shareholder disputes, we almost always visit the business. This is so that if we are examined as an expert witness on the stand at trial, we can affirmatively state that we did inspect the business premises and that what we saw, did (or did not), impact our analysis.
For example, just last year I was working on a shareholder lawsuit where our tour of the business resulted in significant additional value to our client. In this particular case, the business routinely accepted automotive parts on a “core exchange,” but did not record the non-working parts on the balance sheet as scrap inventory (worth scrap value). If we had not toured the business, we would have never suspected that this inventory was even there, and as this was part of an estate buyout, the widow of the decedent shareholder was also completely unaware of the unrecorded inventory. Ultimately, as there were literally hundreds of 55 gallon drums worth of scrap inventory, this added 30% in additional value to our client, whose interest was 50% of the company value.
From our perspective, it is always better to see the business operation and visit with management than not, as there is more to a business than the financial statements and seeing the business first hand greatly enhances our understanding of it.
Tina: Can you appraise my intellectual property?
Joshua: Absolutely! Now that is not to say that it will be easy or inexpensive, but if there is some bundle of rights that our client possesses, we will find some way to value those rights. My firm, Shenehon Company, is known nationally for solving some of the toughest valuation cases where the usual run of the mill approaches fail to accurately account for all of the components of value. Essentially, all property, whether tangible or intangible (IP is considered intangible property), derives or provides some kind of economic benefit to its owner. It does not matter how nebulous of a concept you think you may own, there is some method of valuing it.
As Shenehon Company is both a business valuation and real estate appraisal firm, we have the technical know-how to value intangible rights that are either quasi-business, such as patents, royalties, trademarks, recipes, etc., or quasi-real estate, such as right of way and air rights.
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?
Joshua: This would not be a problem at all, provided you have a reputable business with solid financial records. A small mom and pop operation selling on eBay with the only records being the bank statements will be significantly more challenging. Depending on the business type, we would possibly consider assessing a different risk profile to the company (known as a country specific risk premium) if there are any concentrations that could materially impact the company’s viability (i.e. you sell a large number of farming parts to customers located in Russia). Otherwise, an online business is no different than a brick and mortar business, aside from generally possessing lower overhead costs.
Tina: Is it ethical for an appraiser to help me sell my business?
Joshua: Short answers, yes it is ethical as long as it is disclosed to users of an appraisal. Longer answer: the primary standard our profession follows is called the Uniform Standards of Professional Appraisal Practice. While this is primarily aimed towards appraisers of real estate, there are two sections of the document that deal with business valuation. The central tenant of USPAP is that anything related to appraiser bias is clearly stated within the valuation or appraisal.
Now, while it may be ethical for an appraiser to help sell your business, I still would not recommend it in most cases. Very simply, we are in the business of valuing companies, not selling them. A good broker or investment banker will likely perform a much better job of selling your business for the number you would like given, since that is what they do all day every day. Now, in some cases, certain appraisers may have past experience in brokerage or banking and are capable of selling your business; however these persons are quite rare. The other time we, business appraisers, would be more beneficial than a broker or banker would be in instances where the buyer and seller are already known to each other, and it is merely a matter of working out the terms. Again, as valuation experts, we can be of great assistance in these particular instances.
Very simply, we are in the business of valuing companies, not selling them.
Tina: I have a twenty year old corporation with a strong D&B rating. Is it worth any money?
Joshua: Unfortunately, not much, if any, from a lending standpoint. Lenders are well aware of maneuvers such as selling a corporate shell with a strong credit rating attached. In such instances, the lenders will still require the personal guarantees of the owners/officers of the company. But, if the business has strong profits and cash flow, it will be worth something.
There also may be some value in the rating if a merger is performed with another company that is in the same industry, from the standpoint that vendors or clients are concerned. It would be similar to a reverse merger (a method by which a private company may go public), whereby the acquirer retains the name and corporate structure of the acquired company. If the acquiring company is newly formed or has a short operating history, there may be some value to the buyer in its ability to work with certain clients or source materials from premier vendors that it would not have otherwise been able to do without an established credit history. However, this is obviously very case specific and I would recommend talking this over with an advisor as to how best to locate such opportunities and ensure that it does not run afoul any securities laws.
Tina: I want to find out what my partnership in a business is worth. Do I have to show my partners the appraisal?
Joshua: Not at all, unless you want to. When we are hired by the client, all reports and work product are addressed to the client alone unless otherwise directed. As such, it is your choice whether you wish to share the findings with your partners. We do not share our findings with anyone other than the client, and in cases such as the question above, we would not contact anyone else at the company without first asking the client. We have worked on several shareholder dissent cases, before any litigation commenced, where one of the parties just wanted to see where the numbers fell before making any moves. This is a very good strategy so as to avoid unnecessary legal and professional costs, and diversion from operating the business.
Tina: How long is my appraisal "up-to-date" or “current”?
Joshua: In real estate appraisal, there is a concept called exposure time, or how long the value is expected to hold in the local market place between a willing and knowledgeable buyer and a willing and knowledgeable seller, barring any unforeseen events. Unfortunately, there is not an equivalent for business valuation, due to the widely varying nature of an operating business versus a generally static piece of real estate. This is one of the reasons stock prices on the public markets vary from one day to the next. This is also the reason that we use an exact valuation date; the value ascribed the business is valid as of that particular date alone. With that in mind, a valuation figure for a relatively mature and stable business could nevertheless be considered “good” for three months, again, barring any unforeseen events that would materially impact operations. With newer businesses and start-ups, this is not the case, and the value could change in as little as a week or a month. One other important factor to note is that for estate and gift valuations, the IRS requires the property to be exchanged (i.e. gifted/donated) within a 60 day time frame of the report date, otherwise an updated report is required.
Tina: I own a popular night club in my city and I am preparing to sell it. How long should I expect it to take to sell my business?
Joshua: Selling a business is not an overnight proposition. How long it takes to sell is dependent on a variety of factors, most notable of which is whether the business itself is in a position to be sold. What I mean by that, are the financial statements cleaned-up with all non-business and discretionary expenses removed? Is the company in the midst of a major sales expansion or building expansion as the case may be in a nightclub? Are you the owner mentally prepared to part with the business and give a complete stranger (but not always) access to your company’s most sensitive information? If you answered no to any of those questions, it will take far longer to sell your business than average. Now, with that established, a typical business sells in an average of five to eight months on the low end and 10 to 12 months on the high end.
Without knowing the specifics of your company or location, it would be difficult to gauge how long it would take to sell relative to the average. An owner located in a large city with a vibrant nightlife, such as Miami or Las Vegas, may have an easier time selling than a nightclub owner located in a significantly smaller town, even with less competition to go around, due solely to the fact that the patron count will be lower, and thus less demand to see and be seen at the club.
Tina: Do you only provide appraisals, or do you also help owners with increasing the value of their business?
Joshua: We largely provide appraisals/valuations alone to our clients. However we oftentimes encounter clients who are thinking of selling or in the midst of selling their business and are looking for help increasing the value of their company. When that is the case, we still perform a standard valuation of the company, to gauge where the numbers fall as things presently are. But then, we sit down with the client and go over each line item on the income statement and balance sheet that has the most impact on the value. Nearly every business has one or two major items/categories that drive the value of the company in one direction or the other.
On the more consultative side of our business, we are oftentimes engaged by clients who already know where their problem areas are, and perform work for them specific to certain balance sheet or income statement items. These can include researching market rent and officer compensation, for example. But I must reiterate that these types of clients already know what the drivers of their business value are. If an owner does not know what the key drivers are, this could be a waste of time and money without first performing a full valuation as the wrong indicators could be looked at.
My firm, Shenehon Company, is known nationally for solving some of the toughest valuation cases where the usual run of the mill approaches fail to accurately account for all of the components of value.
Tina: What do the alphabet soup of business valuation designations mean?
Joshua: In the appraisal and valuation profession, there are several acronyms following the names of many practitioners. In my case, for example, I have the letters ASA after my name. This stands for Accredited Senior Appraiser and is issued by the American Society of Appraisers, one of the oldest professional organizations in the industry. What this means, is that I took four classes, passed four comprehensive exams, passed an ethics exam, submitted a log detailing five years of active work experience in the profession, and submitted a demonstration report for review by two of my peers. Needless to say, this takes a considerable amount of time, money and effort to obtain and is not for fly by night practitioners.
There are three other designations that are typically associated with the profession that I would also recommend for potential clients to ensure their valuator possesses. These are: the CBA – Certified Business Appraiser issued by the Institute of Business Appraisers, the CVA – Certified Valuation Analyst issued by the National Association of Certified Valuators and Analysts, and the CPA’s ABV designation, or CPA Accredited in Business Valuation issued by the American Institute of Certified Public Accountants. The primary difference between the four major designations is the amount of work experience required and the professional standards adhered to. The ASA and CBA designations, for example, adhere to the Uniform Standards of Professional Appraisal Practice (USPAP), considered to be the highest ethical standard, whereby the CVA and CPA/ABV does not. These two have their own standards which possess different ethical requirements. The last designation I would recommend a potential client look for is the CFA, or Chartered Financial Analyst. However, this is not as common in our industry as it is in investment banking. In choosing a valuator, the most important factor to consider is whether the person performs valuation work on a full-time or part-time basis. There are many who practice part-time and are thus not able to remain on top of the current trends shaping the industry due to limitations on their time from full-time obligations.
Tina: Do you have any other tips or advice for anyone buying, selling or appraising a business?
Joshua: There are two that we frequently encounter.
First, pay a respectable local CPA firm to audit or review your financial statements if you are not already doing so. This is critical for easing the minds of prospective buyers in terms of their ability to trust what you tell them. QuickBooks printouts are nice for a quick analysis of the operations, but closing the deal still rests on financial statements that are have been assured by an unrelated third party. If this is too cost prohibitive, U.S. federal tax returns are another great source of financial documents to provide, for obvious reasons. My firm provides a fair amount of valuations for bank clients extending Small Business Administration (SBA) financing for smaller acquisitions, and a significant amount of these rely on federal tax returns. However, tax returns have very broad categories and rarely provide the level of detail that CPA prepared statements do, and a significant amount of explanation is generally required to supplement these financial statements when used for valuation purposes.
This leads to my second tip. Please, please, please clean-up your company financial statements three to four years before you intend to sell the business. I cannot count how many times a business has transacted for a lower price than it could have attained due to financial statements that had far too many personal and non-business related expenses ran through the income statement. Trust me, I get it, the perks of being a small business are owner are numerous and include the ability to run your entire family’s cell phone bill through the business, along with your wife, son and daughter’s vehicle repair costs. But unless these expenses are adequately documented with supporting payment slips (which buyers do not want to deal with), it is extremely hard to translate this into value for the seller. As such, it is best to remove these expenses from the income statement altogether a few years before the sale. It is very important for sellers to understand this, as an astute or aggressive buyer will use that against the seller and push for a lower transaction price.